HOW LOGICAL THINKING MAKES LINKEDIN A BETTER INVESTMENT THAN APPLE
The logical mind is a fantastic device for avoiding the pitfalls of society. It can prevent death, jail, isolation, depression, nudity and embarrassment. As an example, logic tells you that driving over 100 miles per hour on a busy freeway that averages 65 miles per hour can kill you. Logical thinking also tells you that the jokes you tell amongst your best friends on an inebriated Saturday night should not be told on Sunday morning at church. Logic can assist you in keeping your opinions of your boss to yourself despite having fantasies of embarrassing him to the point that he falls on the floor in shame and then slithers away, never to be heard from again. Logic also tells you not to stare at a pretty girl as she walks by in front of your wife for fear of ruining the rest of your night. Or potentially your entire week. And in some cases your life.
Logical decisions are to be applauded. When a logical decision goes wrong, people proclaim that you suffer from bad luck or caught a tough break. They pat you on the back, offer you help and want to see you get back on your feet.
Illogical decisions are to be shunned. When an illogical decision goes wrong, you are told about how dumb it was to even think of such a thing. You are offered little help because you are seen as a risk. Your thinking doesn't fall in line with others. Misunderstanding creates mistrust, which creates a self-reinforcing cycle of nothingness. You must then make the decision to become more logical or face life on a piece of cardboard, with a sleeping bag, a tin can and a pet that has somehow landed in the same position you are, having no choice but to stick by you.
Given the type of foundation that has been built for logical versus illogical thinkers in our world, it is only natural that this would carry over to the financial markets. You can't suddenly shut down the mechanism that has gotten you to the point you are in life when entering the world of finance. Even if illogical decisions have created whatever success you maintain, a logical minded world will find a way to frame it according to logic, erasing the illogical aspects of your success. Perception is reality.
Your logical mind enters the financial markets believing that it can thrive by making rational, well thought out investment decisions that have been formulated using the vast amounts of data available to you. Thus begins the process of losing money trading or investing in the markets.
The financial markets are an illogical mechanism that stalks logical thinkers. It doesn't simply want to deprive you of the ability to take money out of the market, it wants to gut you and take everything that your logical thinking has allowed you to obtain up to this point. The more logical an investment seems to be, the more dangerous it can be to a potential investor. The more upside you believe an investment has based on logical thinking about potential of the company based on any metric, study or assessment of the future, the more that investment will eventually make you wish you lived in Tibet, wearing an orange gown and brown slippers all day.
I'm not talking about your average retiree who diversifies evenly amongst companies like Proctor & Gamble, Johnson & Johnson and Pepsi, hoping for gains per annum a couple hundred basis points above long-term government bond yields. I'm talking about the logical thinkers who come to the markets in an effort to make an extraordinary jump in their lifestyle. The guy who wants to put together 20% per year and thinks it will be a cake walk. The guy who thinks 60% gains in the markets can be achieved by reading Market Wizards twice and keeping a list of Gordon Gekko quotes on his desk.
An abundance of logical thinkers in any investment immediately distorts the process behind creating or destroying value. I say destroying value because logical thinkers have a tendency to doubt high-profile companies with high share prices that they cannot dissect logically based on numbers, ratios or a common understanding of the product or service.
Take NFLX, as an example. For months now I have been writing about how NFLX will continue to levels that few expect based on the abundance of logical thinkers who are either shorting or doubting the stock at every opportunity. In February, I wrote an article describing how NFLX would outperform AAPL in the coming months as a result of the dynamic in price.
It's a dynamic that is based on an abundance of logical thinkers who are optimistic about the future of AAPL versus an abundance of logical thinkers who are pessimistic about the future of NFLX. The two opposite frames of thinking create two very different reactions in the price of a stock. Simply put, the optimism of logical thinkers slows the value creation process in AAPL. While the pessimism of logical thinkers distorts and warps the value creation process in a company like NFLX to the benefit of the share price.
LNKD is the new face of logical thinkers creating a steroid effect on a company's stock price. I wrote about how investors should be careful in their doubt of LNKD a few days after it debuted on the market. The illogical market cap that was assigned to the company in its debut was a prime example of how logical thinking fails when it comes to the assessment of where a company should be trading. The dynamic that took place from the first day LNKD began trading was unknowingly fueled by a swarm of logical thinkers who believed that their logical mind was superior to the illogical mechanism that drives the financial markets. The greater the disparity between the opinion of logical thinkers and the illogical mechanism that drives the markets, the greater the potential for explosive price movement. LNKD has nearly doubled off its lows over the past several weeks.
An abundance of logical thinkers doubting a company like NFLX or LNKD always ends up forcing the market into illogical price action. Similarly, an abundance of logical thinkers who are optimistic about the stock price of a company based on rational assumption and thought will erode the process of value creation. When there is little in the way of illogical thinking that creates confusion amongst an investor base, then the value creation process ceases to function correctly. Therefore, it must be assumed that illogical price action that is not easily understood by logical investors is a key catalyst behind above average gains in high profile companies.
GOOG when it IPO'd in 2004 was greeted with an abundance of doubt by logical investors. The thought of a triple digit internet company made no sense irrespective of the merits of the company. It took years and a gain in price of several hundred percent to allow logical investors to wrap their minds around the company. At the point in which they greeted the stock with logical expectations and acceptance, the value creation process stalled. GOOG has essentially gone nowhere since the middle of 2007.
In 1999 and 2000 logical investors loved tech stocks, embracing them with their entire net worth. I remember reading articles about how QCOM would dominate the wireless world in the coming decade. The devices coming downstream would all require QCOM chips. 3G was said to be the future.
We're living in that future now and that assessment was right on. However, an abundance of logical investors involved in QCOM and every other technology company completely destroyed the pricing mechanism. The company that was set to dominate the future of wireless went from 100 to near 10 at the 2002 lows. The passion of the logical mind for the company turned to a logical disdain for all things internet, wireless or technology. It was only when the logical mind no longer was able to see what was down the road for QCOM that it was able to move forward.
There is an endless stream of examples. New ones pop up every single year. In the never ending quest to understand what makes the financial markets tick, one component that should never be forgotten is the ability for prices to go beyond the point that any single investor can imagine. The desire to deceive and surprise investors is tattooed across the markets forehead. For that reason you must allow your logical mind to remain what guides you through everyday life. However, when you enter the financial market arena, it is imperative to shut it off and allow your mind the creativity to imagine illogical pricing scenarios (both to the upside and downside) that only a kid could dream of.
My 5 year old just came into my office with a green mask and a laser gun telling me that giant aliens with red eyes are outside and he needs my help fighting them. I have aliens I need to kill. Practice makes perfect.
