The Folly of Crowd-Following: Popular Stocks=Unpopular Returns

by Edwin D. Everett

Moderating energy prices and inflation measures have lifted investors’ spirits of late. But lest this brighter outlook cloud investors’ judgment too much, we offer a cautionary tale of what enthusiasm can do to returns. This article focuses on the perils of following the crowd into super-popular stocks.

For as sure as fear and greed drive the stock market, when it comes to popular stocks, in particular, greed inevitably gets the upper hand. And investors end up with a losing hand.

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The reasoning starts out logically enough—the stock of a company that is growing is worth a premium over one that is not: the more rapid the growth, the greater the premium should be. But almost without exception the fastest-growing companies get bid up to unrealistic and unsustainable levels by unbridled investor enthusiasm. Greed, wishful thinking, and naive extrapolation of past results push valuations far above anything justified by realistic, sustainable earnings growth. With an impossibly high bar for management to attain, disappointment is the typical end result. This is how today’s highly popular stocks usually end up tomorrow’s losers—sometimes spectacularly so.

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