Buy hope, hold hype, sell hysteria

A successful self trader – Rule # 27

This rule almost, always holds true. The best time to buy a stock is when the hope behind a stock is yet to play out. Hype is when the earnings may not grow but the valuation, as defined by p/e ratio grows. Hype is the time to hold on to your stocks. Hysteria is when everyone wants to buy and the market talks about; this time it is different. It happened to hardware, software, biotech and the internet. Eventually, hysteria meets a sad end.

GETTING INTO MARKETS AT THE RIGHT TIME…

Sir John Templeton was the man who identified emerging markets as an asset class, long before it became an allocation fashion. A large part of Templeton’s power and reputation today owes to their founder’s courage to buy on hope. Turning points in a stock are normally made when pessimism begins to transform into hope. Investors who get in at this stage get the multi-baggers.

Hype is so easy to understand, but so difficult to articulate. But you surely know when hype exists. Hype happens when the stock has proved itself in terms of earnings, growth and institutional interest. At the hype stage, the larger mass of retail investors starts entering the stock. This is also the stage when the stock sees a substantial expansion in P/E. Remember Infy in 1999 and DLF in 2007.

Hysteria was best explained by John Mellencamp. According to John, “When you live in hysteria, you start thinking emotionally”. Stretched as it may seem, that is exactly what hysteria is all about. Investors and traders just pile on to the stock thinking it will defy the laws of gravity. It never does and the result is disastrous. You need to catch hysteria pretty early.

WHAT CAUSES HOPE, HYPE AND HYSTERIA

HOPE IS NORMALLY A SAVVY INVESTMENT BET

Hope starts when there is a long term bet on a trend. Examples are; a bet on connectivity via Bharti or a bet on generics via Sun Pharma or a bet on gold prices via Titan. You almost need to look at the investment like a call option with zero residual value.

HYPE IS WHEN THE COMPANY WALKS THE TALK

An Infosys or Reliance took many years to move from hope to hype. Scalability, growth, market leadership and margins came over many years. Hype is when the investors are willing to pay a premium valuation for the stock. This stage separates the men from the boys.

HYSTERIA IS WHEN IT IS PUBLIC KNOWLEDGE

Interestingly, hysteria is when everyone wants a slice of the story. The day you hear that this time is different, you can be dead sure that it is hysteria. Smart investors must get out as soon as the first signs of hysteria are visible. Get smart!

Hysteria is like a biotech company with 100 scientists, zero revenues and a billion dollar valuation” – Peter Lynch

FAMOUS INDIAN CASES OF HOPE, HYPE AND HYSTERIA

  1. Hope is when value is least apparent and most likely. Hope is buying Infosys at 100 in 1995. Hope is buying Bharti at Rs.18 in 2003. Hope is buying Eicher at Rs.180 in 2009. Each became a multi-bagger over the next 5 years. If you ever want to create wealth through equities, you have to bet on hope.
  1. Hope is also when the power of compounding works best for you. Imagine buying a stock at Rs.2 (SAIL in 2002) and it goes to Rs.40 in 2 years (a 20-bagger). Had you bought the stock Rs.8 higher, you stock would have been just a 5-bagger in 2 years. That is nothing to write home about. When it comes to hope, the earlier the better!
  1. Hype is when the short term value is most apparent. A 50% return in one year is surely not a multi-bagger. But for a savvy investor, that is a lot of money in a short time. Hype is when the stock is ripe for short to medium term trading. Buy on dips works perfectly on such stocks during the hype phase.
  1. Hype is also the stage when there is a broad-basing of the ownership pattern of the stock. The number of institutions owning the stock increases. There is widespread retail interest also coming into the stock. This is also the stage when the P/E of the stock expands towards the upper end of the sector spectrum.
  1. Hysteria normally begins with theories and ends in tears. It is all about theories. How internet redefined business was a theory that would give perpetual value to tech stocks. Land banks were touted as another asset with perpetual value. Most theories try to sell the idea that this time is different. It rarely ever happens.
  1. Hysteria is the last stage and hence its length and ferocity is hard to predict! But suffice to say that the earlier you get out of the stock the better. The hysteria on Himachal Futuristic lasted for quite a few months in 2001. But when it exploded, the stock was on lower circuit for 3 days in succession. The final turnaround in hysteria is normally impossible to predict. Better safe than sorry!

HOPE, HYPE AND HYSTERIA IN PRACTICE

Every stock invariably goes through these stages. In fact, even the overall market goes through this phase, but is hard to predict in practice. Infy from 1995 to 1998 was typically a story built on hope that software would redefine the contours of Indian business. L&T from 2005 to 2007 was a case of hype, when there was a rethink on valuations and discounting. And lastly, Unitech in 2007 was a case of hysteria, when land bank took precedence over actual sales.

The distinction is extremely important. But there are some key questions. How do you differentiate between genuine business hope and a smart sales pitch? How do you identify when hope ends and hype begins? These are questions you can only answer with genuine understanding of the business as well as experience. Hysteria can, however, be quite seductive and the smart investor is one who exits early, even at the risk of opportunity losses. These are the investors who live to fight another day in markets.

TAKEAWAYS FROM THE “HOPE, HYPE AND HYSTERIA” DEBATE…

As the old saying goes in the market, “Hope is when the investor gets excited and the rookie is disinterested; hysteria is when the rookie gets excited and the investor loses interest”. A smart investor is one who plays each phase long enough to ride the wave and quick enough not to get caught on the wrong side. Once you are able to identify which phase the stock is in, the rest of the job becomes fairly simple. The next time you identify a stock, try to find out which segment it will fit into. Is it a case of hope, hype or hysteria? That could be your starting point in your investment decision. As they say, something well begun is as good as half done.

As Jesse Livermore famously said, “There are times money can be made by holding on; times when money can be made by jumping in and times when money can be made by jumping out”. Identifying a good stock is just part of the story. Bracketing them in the right stage and playing accordingly is the bigger challenge. The day you can do that, it is your first step to smart investing.

You can ask us your stock related questions with #AskReligareOnMarkets via our Twitter channel @religareonline

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