The dividing line between Hope and Hype

There are numerous instances in life when investors are unable to differentiate between Hope and Hype. To the intelligent and the informed (if ever there are in the stock markets) hype is exaggerated and unrealistic hope. While the words sound quite similar the after effects of each of these waves are extremely contrary to one another. Hope lends light to life while hype leaves behind financial scars that are difficult to get away from. Very often in cases of hype the music stops but the people are still seen dancing. It is painfully ironic that both hope and hype are four letter words.

Sir Isaac Newton remarked in the early 1700’s, “I can calculate the motion of heavenly bodies but not the madness of people”.

It may be of significant interest to the bruised and battered bulls of Himachal Futuristic and DSQ Software (Stocks that fell 99% and more off their 2000 peaks) that Newton doubled his money in the South Sea Company. He made a profit of 7,000 pounds and then the hype got to him again. He re-entered again at the peak and lost 20,000 pounds. Did any one say that even Newton could not defy the laws of gravity?

Many would say that the Nasdaq rise in 2000 was hype. The 2000 tech bubble was a complex mixture of  hope with hype. Initially till 1998 stocks rose on hope - thereafter the rules of the game changed from revenue and profitability to eyeballs, number of web site hits and so on. While smart investors cried hype and bought on mistaking the hype for hope the lesser intelligent mortals as usual were the first ones to be trapped. The wonderful thing in hype or momentum investing is that people expect the end to be sudden painful and catastrophic but refuse to accept that they could be trapped.  “ Behti Ganga mein haath dho lo” (Wash your hands in the running river) is the common advise and “It is different this time” is the general mistake. In stock market parlance this is known as “Momentum Investing”. Caveat emptor - the running river surely has the power to run away not only with your hand but also with your house. Usually the hype again ends with hope – the hope to make good your losses but betting on this hope is hopeless as stocks rarely retrace their peaks in a hurry.

How do you spot Hype: Analysts, investment bankers and stock market commentators give out the first signs of hype. Whenever the basic rules of investment are altered and changed to suit the already absurd looking valuations one may conclude that hype is engulfing hope. The replacement cost theory in 1992 took me over. When I bought shares of Tata Steel at 700+ in 1992 (at the height of the Harshad Mehta boom) I desperately tried to convince friends and relatives that the cost of setting up a Steel plant of equivalent capacity would far exceed the market capitalization of Tisco, I was upbeat on the land at Jamshedpur, the cross holdings that Tisco shared with other Tata group companies and lo and behold after a dozen odd years I am yet to see that price leave alone the interest. Why should we talk about interest as they refuse to calculate interest in stock investments perhaps inserting the interest element would make stock losses look more concerning then they actually appear to be?

In 1989 the Japanese Stock Index (Nikkei) sold at 70 times forward earnings and at 40,000 investors were still betting on the bulls. Probably they were betting on a price earning expansion from 70 to about 100. Hype was certainly enveloping the air. In the next decade and a half the Nikkei has given away 75% of its 1989 peak.

During the 2000 tech bubble or shall we call it a tech balloon when analysts and investment bankers were unable to justify the phenomenally high and absurd valuations of internet companies a new word was discovered “eyeballs”. The magical theory of eyeballs substituted Cash flows, Revenues, Net profits (the traditional theories of equity valuations). People were basing calculations on the growth in eyeballs year after year. One of the largest Indian Software Companies (Satyam Computers) bought an obscure looking Internet Company for Rs. 499 crores. History was made and all leading newspapers pink and white carried photographs of the smart gentleman who sold a company with sales of about Rs 1 crore at almost 500 times sales. Now did you ever think that it is only the retail investors who invested on hype?

How can Retail Investors safeguard themselves: Many investors assume that periods of hype are the times to make money. Just buy at the initial signs of activity and sell at the top. For the intelligent however hype is the time to safeguard his wealth, his house and also his shirt.

The strength of character in a retail investor lies in fending off these hypes. When he watches his neighbor changing his old Maruti for a Lancer a desire to graduate from a motorcycle to a car is bound to generate. Unfortunately after a while both of them are seen looking for rented one room apartments swearing never to see the face of the broker and the markets.

A man of strong character would fall back to the basics probably invest some money where he sees reason rather then hype. All great investors including the likes of Warren Buffet advise investors to pull out of the markets but to me that kind of a foresight is neither existent nor expected. Only if investors were to avoid stocks in which the hype factor exceeds the hope quotient the battle is won. After all the trick to investing in the stock markets is to avoid losers as much as it is to pick up the winners.

A few interesting moments when the world went Hype(r)

How many times have we seen the Indian markets going up on the basis of high FII flows the previous day? Well as they say markets are never wrong only opinions are. It is really a very confusing and complicated place to make a living.