Wednesday, September 19th, 2018

Beware of Alternative Methods for Evaluating Stocks

 

When the Chinese stock market peaked and then crashed a couple of years ago one new Chinese investor was confused. He picked stocks using lucky words and numbers and it did not work out. Back in the 1920s people played the stock market as prices steadily climbed only to lose pretty much everything in the crash that ushered in the Great Depression. The dot com bubble was going be different as pundits said the market was different now and the old concepts of intrinsic stock value, P/E ratios and balancing a portfolio were out of date. The dot com bubble was followed by the dot com crash and then interest rates went to virtually zero and we got not only another stock market bubble but a real estate bubble as well. And then came the 2008 crash and the Great Recession. Our advice is to beware of alternative methods of evaluating stocks because they always come with a price, sooner or later. Business Insider writes about the alternative paradigm that investors seem to be using these days.

Greenlight Capital, a $7 billion hedge fund founded by David Einhorn, told clients that the market may have adopted an “alternative paradigm” for calculating the value of stocks. Given the performance of certain stocks, we wonder if the market has adopted an alternative paradigm for calculating equity value. What if equity value has nothing to do with current or future profits and instead is derived from a company’s ability to be disruptive, to provide social change, or to advance new beneficial technologies, even when doing so results in current and future economic loss?

Politicians learned long ago that simply having your name in the news is enough to get votes. Pols did not care what the newspaper said so long as their name was spelled correctly. Today fledgling investors look in Google for information about stocks and you can often make a short term profit by just picking the stock that had the most Google searches this week. Our sister site, Profitable Trading Tips, wrote about trading volume and Google trends.

Trading volume and Google trends seem to be associated according to just published scientific research. It turns out that looking at Google searches for stock information correlates with higher trading volume of the same the stock the following week. The scientists note that their data does not tell us is the stock is going up or down but it does reliably predict higher trading volume. So, if trading volume and Google trends are linked can profits be far behind for the astute trader?

Following trends on Google makes sense if it reliably predicts market activity. Likewise watching the news to see which stocks gets the most attention may be useful for short term trades. But these should be useful indicators and not alternative methods for evaluating stocks. Years ago a trader friend used to buy Barron’s at the newsstand on Saturday. It was delivered by mail the following week. He would read it to see if there were any useful analyses of stocks. When there were the stock typically bumped up between 10 and 30 percent and the bump lasted for a month or so. He made money by purchasing selected stocks this way and rarely held those stocks longer than a month. This alternative method of evaluating stocks worked for the short term but was useless over the long haul. Traders should keep this example in mind when evaluating stocks in the current market.

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