YOLO, FOMO, and am I crazy or is everyone else?
Let’s talk about manias, or in the words of former Fed Chair Greenspan – irrational exuberance.
According to Investopedia, Irrational exuberance refers to investor enthusiasm that drives asset prices higher than those assets’ fundamentals justify.
We have recently been fielding questions from clients as to whether or not the market as a whole or a specific security is overvalued (e.g. bitcoin, Tesla). Spoiler alert – We do not know.
Even still, we thought it would be interesting to put together a multi-part series on the topic of valuation and exuberance.
Part 1: GameStop, Tesla, and Amazon – What is the difference between mania and speculation?
Let us start with recent news.
This week, GameStop’s stock surged by more than 450%. In a week. This is the same company that in September announced it was closing more stores than expected and did not even earn a profit in 2018 or 2019.
Was there an earnings announcement? No. Did they find a pot of gold under one of their stores? Not that I am aware of. Was there any news whatsoever? No, and yes…
The company did not announce any news but apparently a ton of Reddit and Discord users dog-piled into the stock pumping it ever higher and creating a virtuous cycle of musical chairs. The whole episode has nearly toppled hedge funds, raised alarm bells at the SEC and Congress, and enriched a select group of lucky people.
So, is that mania?
You are probably rolling your eyes and saying “yes, that one is easy to identify.” If it is so easy to identify mania then why are investors still piling in? Is it the fear of missing out (FOMO), is it the belief that some other “sucker” will pay more later or do some of these investors really believe that GameStop is undervalued?
This got us thinking. Irrational exuberance drives manias but how is a mania different than intelligent speculation and can you identify it in the moment?
We believe a specific stock or even sections of the market can look over or under valued at any given point in time. That does not mean they are. Valuation of an asset is based on all available information today, but more importantly, the likely anticipated outcomes in the future.
That means that the answer to the over/under value question is not yes or no but rather, what is the likelihood that profits will follow to justify that valuation.
As an example, I have felt that Tesla’s stock is overvalued for a long-time. Not because it is a good deal at $X price but because the future will have to be near perfect to justify its surging valuation. Just because I feel that way does not mean it is overvalued. In fact, I felt the same about Amazon years ago and it has proven me and many others wrong. Here is some proof of how wrong I was…
In 2013, Amazon stock was up nearly 59% for the year, dwarfing the NASDAQ and nearly every other major index. Their profits had been negative earlier that year (and would go negative again in 2014). There were many well respected critics who felt the rise was totally unjustified.
Look at the language used below, the word mania isn’t used but it’s pretty much implied:
11/4/2013 – Amazon’s stock reminds me of the game of musical chairs. As long as the tune of irrational exuberance continues to play, then shareholders dancing around Amazon’s highly valued shares can continue to enjoy the siren song of extreme optimism. – Advisor Perspective Magazine
11/23/2013 – “How everyone is so willing to wait. That they’re going to be a Walmart one day, they’re going to finally have a profit margin of some significance, and they’re finally going to make some money… I kind of watch it every day, mystified by its superman characteristics.” – Jeffrey Gundlach
Well? We all know how that story has played out. Amazon stock now trades at 10X its value on 12/31/2013. Its trailing twelve-month profits are $17 – capital B – billion and the comment about being the Wal-Mart one day? They eat Wal-Mart’s lunch.
So, was Amazon overvalued then? Was it a mania?
With the benefit of hindsight, I would say no to both. There certainly could have been elements of mania, but investors during that time could probably put into the camp of speculators. A lot needed to go right for them to profit and the future was definitely not certain. Even with the benefit of hindsight, you can still understand why some felt it was a mania at the time. The point is that it is incredibly difficult to discern between a mania and speculation especially in the moment.
To be clear, I am not advocating that you purchase or don’t purchase GameStop stock (or any other one for that matter). That is not the point. The point is that if you are an investor you should care about likelihood of outcomes. For our part, we prefer diversification and a much more boring approach to investing because the odds are in our favor for the long haul.
If you are one of the lucky few who have made money in these rollercoaster stocks – good for you. Just remember, going forward, the question is, “who will be left standing when the music stops?”
See you next time to talk about the drivers of mania. We’ll also unpack the question that is on a lot of people’s minds – “is the market overvalued?”
P.S. – As I was penning this article, the WSJ had a great piece outlining the GameStop mania. You can find it HERE