Beware Of ‘Story Stocks’

This article was written with Jim Cahn, the Chief Investment Officer at Wealth Enhancement Group. It was part of a series of articles developed under an agreement with Forbes to work with a variety of contributors and assist them in delivering actionable investment ideas each week. The site is one of the top 500 sites in the world with nearly 10 million subscribers and nearly 100 million page views a month.

Whatever you might think of Apple you certainly can’t avoid it if you scan any financial news. Taking a look just at Yahoo Finance! headlines, a new story about the iPhone behemoth comes out at the rate of nearly one every five minutes. By comparison, at the same time, Verisign – also in the tech space and hardly an obscure stock – had been written about only once, seven days earlier.

I’m not picking on Apple. There are a lot of story stocks. In 2011 it was LinkedIn . Last year it was Facebook  and Groupon . This year, in addition to Apple and Facebook, RIMM — now Blackberry — and Yahoo have joined the fray.

A lot of investors think they should pay attention to the press coverage. I think the opposite is true. The press isn’t in business to help you make money; the press is in the business of selling advertising. The pundits and practitioners that fill the airwaves and pages of investing magazines are giving their readers what they want, including in some cases, hype and hyperbole.

Because of the press coverage, clients ask about Apple all the time and here’s what I say to them: We have no idea what’s going to happen to Apple. They have great products but everyone already knows that. There is no reason to assume we — or any other investment manager–has an edge on the direction of Apple’s stock. Just think, if you had an edge would you want to publish it all over the airwaves?

All this energy around stocks heavily covered in the media seems to have a impact on returns. Academics have studied this phenomenon, including Lily Fang and Joel Peres, both at INSEAD.

Overall, the academics collectively conclude that highly publicized companies tend to, but not always  underperform those with little publicity; since they attract a lot of capital that alone can push prices above a level which could by justified by another metric like cash flow. These academics made another interesting observation: the more a company is covered, the more disagreement there is amongst professional analysts about the future performance of the stocks. That’s a big surprise.

One would expect that media coverage would provide more information and a common set of facts which would lead well trained analysts to the same conclusion. In fact, more information seems to lead to more disagreement. We don’t know why this occurs, but if the professionals can’t seem to sort out the mess of information flying at them about hyped stocks, then certainly the average investors can’t.

More evidence that you may want to shun stocks with a lot of attention comes from a paper by Joseph Engelberg, Caroline Sasseville and Jared Williams. Their paper, “Is the Market Mad? Evidence from Mad Money,” traces the typical returns for stocks touted by former hedge fund manager Jim Cramer on his CNBC television show. That paper demonstrates that after Cramer mentions the stock, it soars as investors rush in. Nearly all the upside generated from a mention by the energetic TV host of Mad Money, however, disappears within 12 trading days.

There are hundreds, maybe even thousands, of reasons why Apple is so heavily covered. Its stock has ricocheted between $390 and $700. Its products, the iPhones and iPads, are ubiquitous. After years of being led by charismatic founder Steve Jobs, the company has struggled to replace its visionary and creative genius.

None of this really matters.

The point is if you buy (sell or hold) Apple – or any story stock — based on what you read in the news alone, you’re investing for all the wrong reasons. In other words, whether it’s Apple or a bio-tech promising a cure for cancer, if you’re basing your investing decision on news and hype, you’re picking based on hype, which may not be the best way to make an investment decision. As always, when it comes to investing, please make sure to consult with your advisor about your specific situation, as stock investing involves risk, including loss of principal.

Click here to see the article on Forbes.

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