Updated: Feb 21, 2021
Heads are spinning over the recent fluctuations sparked by new entrants into the stock market and the potential appetite for speculation it displayed. The sudden appearance of millions of new members of the Reddit forum – and the recent GameStop frenzy it appeared to spark - raises some interesting questions around the speculative practices motivated by social media or popular influencers.
Influence vs Information:
There are any number of factors that can affect the market. Some are based on tangible value, as in a new pandemic vaccine or the newest electronic device release, for example. But some market impacts come from variables completely unrelated to data and more tied to a popular figure or a social media trend. While it happens all the time, market manipulation untethered to facts about a company’s or industry’s financials is really more speculation than it is investment.
When public figures say something on social media, it can influence not only what people think is going to happen, but can actually cause the
to move in one direction or another, regardless of how that company or sector is performing. Be aware of the agendas of those leveraging these platforms and use common sense regarding decisions that can affect your financials. While influencers may get a lot of people on board with ideas, it can sometimes be a fact-free zone. This isn’t a commentary on the free exchange of ideas. It’s simply an acknowledgement that celebrities may have their own agendas, or at least may not recognize how their ideas could impact others’ situations. And it also poisons the well for legitimate advisors who truly have investors’ interests in mind and the knowledge to back it up.
We just saw a historic example of the reach and impact of this type of influence in the jolt the market endures in connection to a small retailer that had previously flown well under the radar: GameStop.
What Happened in the Recent GameStop Craze:
The GameStop trading phenomenon boiled down to this: individual investors — many of them followers of a popular Reddit page called Wall Street Bets — banded together against Wall Street hedge funds that had bet that GameStop’s shares would fall. These novice retail investors pushed back by buying shares and stock options in droves, causing GameStop’s market value to increase to over $24 billion from $2 billion in a matter of days. This surge created an artificial “microbubble” in which the price per share went up quickly and then back down again, as the surge was not attached to any “real” value in the underlying company.
Interest in Investment is Great, but….
Recent events – most notably this GameStop issue – have demonstrated that the next generation is inspired to start investing in the stock market. While this is certainly an exciting development, remember: when you hear something that sounds too good to be true it probably is. That being said, if you are going to invest, it’s important that you do your homework.
Here are some tools to assist with basic due diligence:
Consider the credibility of the source providing advice; is their opinion based on verifiable data or facts?
Do a little fact checking on the company. Use sites like Morningstar or Yahoo Finance to look up a company or stock symbol online. Check out its historical performance, including some of the technical fundamentals such as the P/E ratio, PEG Ratio, Price to Book Ratio, Price to Book Ratio. If these terms sound confusing or overwhelming, see below.
Consider finding another related company or stock to see how the big picture compares; if there’s an anomaly that separates them, find out why to provide some context. Most financial sites listing stock or company information also have links to recent news. Your goal is to make sure the fundamentals are sound and be aware of a possible “flash in the pan” inflating value.
Translation Please? Basics to Assess Investment Value:
Here’s a quick primer on what the different ratios are and why they matter:
1. Price/Earnings (P/E) Ratio: The price to earnings ratio or P/E ratio is the company’s share price divided by its annual per-share earnings. Consider how the company is doing compared to its industry peers.
2. Price to Earnings Growth (PEG) Ratio: This looks at the expected growth of the company over the next few years. Companies grow at different rates, so a fast-growing company can be cheaper than a slower-growing company.
3. Debt/EBITDA Ratio: This is a great metric for a beginner investor to look at. It measures the amount of income generated and available to pay down debt before covering interest, taxes, depreciation, and amortization expenses, which reveals a company's ability to pay off its debt. A high ratio result could indicate a company has a too-heavy debt load. Debt isn’t necessarily a bad thing; however, companies can be “over-leveraged or vulnerable if there is too much, especially if there is a major market disruptor we can’t control. Think of recent events like COVID, government policies regarding trade, etc. and how cash flow and profits can be impacted if companies find themselves unable to meet their financial commitments.
4. External Factors: Consider market considerations that make that company stand out. Are there any major headlines about this company that sound out – either as warnings or positive indicators? Dig a little deeper to check out the core growth and stability factors. For example:
Do they have a competitive advantage that is sustainable and long-lasting? Is it a trusted brand name?
Do they have a patent that allows them to compete strongly against their peers?
Do owners have a successful track record of managing strong, stable companies?
Are they in line with industry trends? Does their product appear to be sustainable?
These basics just scratch the surface, but they offer some guidelines that can help understand the true value of a potential investment. The bottom line is that you should do your homework and try to gather information to inform your decisions.
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