TRIUMPH OF THE ILLOGICAL, MUTANT HYBRID INVESTOR
Illogical thinking, by definition, runs contrary to prevailing rules or wisdom. It is often times seen as a reckless act that can endanger one in any number of ways. Whether through injury, incarceration, disease or even death. It is illogical thinking that is often blamed for the travails of an individual.
It goes without question then that the average investor will have great difficulty in grasping onto the concept of illogical analysis often times leading to the best results. There is no means of contrasting illogical thinking in finance with illogical thinking in everyday life. We can simply put illogical thinking into the basket of bad things to do, without regard for context.
Let's look at all of the illogical events of 2013 thus far:
- TSLA is up about 400% this year. Coming into 2013 it was heavily shorted, range-bound and overlooked as an investment by most. It is trading at 15 times sales, 33 times book and more than 100 times forward earnings. Logical arguments, such as comparisons in valuation to other car manufacturers, are thrown at the company everyday. Illogical by any stretch.
- YELP is up nearly 250% this year. This is the only social media stock that I have issued a research report for way back in April of 2012. My core reasoning for the investment was that it was so illogical that it would be proven correct. In fact, I ended the research report with this: I am comfortable, however, that there is substantial upside to be had here as rational thinking fails investors once again. An illogical move in YELP this year by an stretch. But once again, a powerful move.
- LNKD continues to appreciate dramatically on the basis of seemingly illogical appreciation. I 2011, I posted an article about how the dynamic between logical/illogical thinking makes LNKD a better investment than AAPL. Logical thinking doesn't win on Wall Street, in any way, shape or form.
- FB is up nearly 50% this year. When the company was trading below 20 there was nothing but logically based praise for a market that was treating FB as it was supposed to be treated. Logic explained perfectly well why FB not only didn't deserve a valuation at $20 per share, but likely was a single digit stock. The typical articulate incompetents that reside in the hedge fund world even chimed in, this time via SumZero, with a research report about how FB was headed to $10 per share. Logical thinking maims investors again.
- The market itself is the perfect study into the power of illogical thinking. There is not an analyst out there who was illogically minded enough to call for a 15,000 Dow a couple years ago. Yet here we are, in a seemingly illogical bull market that a majority of individuals, analysts and fund managers still aren't properly grasping onto. It doesn't mend well with the logical mind. That simple.
What is it about illogical analysis or better yet, opportunities that cannot be dissected utilizing traditional analysis that results in such dramatic movement in price?
The fundamentals of price movement or appreciation seem to soften when an abundance of logical thinkers enters an investment. The boat becomes top heavy, eventually leading to a capsizing, with investors being strewn across the sea in various states of hypothermia. Logical thinkers come to same conclusion at often times identical times. Meaning a rush into a stock that isn't sustainable, causing any potential for future appreciation to vanish, after a short burst.
However, when seemingly illogical appreciation takes place in an investment, a completely different dynamic takes place. It is often as follows:
1. Investors trickle in slowly, as skepticism that is brought about by the logical mind, slowly gives into the emotion of greed in wanting to make money off the move and the fear of missing out on further gains.
2. Short sellers become involved, creating an entirely new dynamic in appreciation. These are often institutional investors who are often drowning in logical based analysis. Your average hedge fund analyst, mutual fund analyst etc. This also involves individual investors who continue to grasp onto logically based expectations of value creation, until they are forced to question their hypothesis. More fuel for the upside.
3. This feeds into point 1 & 2, but deserves to be mentioned separately: Seemingly illogical price appreciation, marked by seemingly absurd valuations, takes a substantial amount of time to settle in with investors. During this time, there will be short selling and a lot of hopping in and out of the investment. When investors, as a whole, start blurring the line between their logic based analysis and the illogical (in other words, when capitulation takes place), in an attempt to justify either permanently covering their short position or taking a long-term position in the company, the trend will often times reverse, either permanently or temporarily.
You can see that in the case of the logical investment, the realization among investors is sudden, with little fanfare from short sellers or traders. This is then followed by an arduous path forward that is murky, choppy and less than fulfilling for investors. The market often times causes investors to give up from the exhaustion that comes with opportunity cost more than anything else.
In the case of illogical investment, you have small regiments of investors who experience the overwhelming emotion of fear and greed that supersedes the logical thinking that kept them out of the investment in the first place. This creates appreciation in the stock price that proves sustainable over the long-term. Additionally, the involvement of the trading crowd reinforces the dynamic.
The most profitable opportunities will never appeal to the logical mind. If they did, then the opportunity would be compromised before the trend even begins.
Doesn't make sense? Good. Now we're getting somewhere.
