Should you be buying the latest bubble?
Utterly empty vessels, debt vehicles, hot air, baseless, ramp stocks, junk, the next big thing, the future, my wife will divorce me unless this goes up. Call them what you like, but every now and then a new FOMO asset class emerges from, seemingly, nowhere and goes parabolic quicker than a Tesla Model S 0-60 sprint.
Welcome reader, to the wonderful world of bubble stocks.
I’ve written previously about the self-fulfilling prophecy that perception is greater than reality. And a stock exchange could not be a better setting to witness such emotion-led market psychology play-out.
Now before I go any further, it’s important to note that these ‘hot air’ companies may not be completely baseless forever. They could blossom into fully fledged, profit making machines. But in their current guise, they’re nothing more than a well backed elevator pitch. A concept. An idea. An aspiration even.
And every year, a new bubble emerges. Driven by a Twitter storm of excitement and elevated by hope of a new, untapped, wealth creation source. TikTok traders, Reddit’s WallStreetBet punters’ and RobinHood bros combine to make an almighty wall of buying power.
“Perception is reality and like the tulips imported from the Middle East in the 1600s, the perception (at the moment) is that these companies will blossom into the next Tesla success story.”
Let’s start with a quick history lesson on bubble markets. This is not a new phenomenon. Not by any stretch. In fact, I can take you all the way back to 1634 when TULIP MANIA was running wild.
That’s right, tulips - literally a flower (a pretty flower none-the-less).
For the sake of getting to the good bit about if you should buy EV stocks or not, I’ll compress this history lesson as best I can.
It’s the 1600s and well-off middle-class Dutch merchants felt it best to display their fortunes by importing luxury items from the Middle-East. One of those exports which commanded the same exoticism as spices and intricately woven rugs was tulips. By 1634, tulips were filling the gardens of those wealthy Dutch merchants and became the ultimate display of one’s financial surplus.
By 1634, if you didn’t have a vulgar display of tulips in your garden then who even were you?
And so ensued mass hysteria. So much so that the price of a rare tulip would cost as much as $750,000 in today’s money. Astonishing. That’s probably the same price as the very apartment I live in right now (which I considered overpriced when I bought it). Except, you can’t live in a tulip.
Unless you’re really really small, in which case crack on.
Let’s fast forward to 2020 and the flavour of the month is electric vehicles (the EV market).
Leading this year’s class of inflated stocks are Workhorse Inc, Fisker, Tesla (named after Nikola Tesla) and Nikola (named after... you guessed it, Nikola Tesla. Seriously, any losing team from a Lord Sugar Apprentice task could have come up with a more original name, jheeze!).
This all started with Tesla which, for years, was written off by the ‘smart money’ – myself included.
And every year Tesla’s share price proved the doubters wrong and made the smart money look, well, a bit dim. I could write a whole separate piece on Tesla’s extraordinary valuation.
In fact I have, which you can view right here.
For the frustrated traders who missed out on the Tesla gravy train, the mission is simple – find the next potential hyperbolic stock and tweet about it until your fingers burn off.
They didn’t have to wait long!
So eager in their pursuit, ultra-early stage companies like Nikola and Fisker saw their share price increase by over 100% YTD. And when I say early stage, I mean it’s still at concept stage, not a single spanner has been lifted. No tyres have been ordered. In its most rudimentary form, you could almost call it nothing more than a pitch deck PDF.
I may mock their lack of tangible existence, but I can’t mock their valuation which has become very real indeed. Just look at the following market caps for these stocks;
Fisker - $1.1bn
Workhorse - $3.3bn
Nikola – A whopping $11.6bn
Granted, I’m sure all these companies have some very clever people at the helm and an aggressive strategy to take them from conceptual mood board to rubber on the road. But even still, how are they commanding such lofty valuations?
Relatively and comparatively speaking, they shouldn’t. That’s the short answer.
But it’s back to that old adage, fear of missing out (FOMO). Tesla once started out as just an idea and is now worth $500bn a short few years later. I can trawl through their balance sheets, assess their credit rating, weigh up the competition, scoff at the crazy valuation and console myself by finding a fellow naysayer online who agrees with me. But it doesn’t matter.
If the buying momentum outweighs the smart money snobbery, then it’s time to have a reality check. After all, the market only exists because a difference of opinion exists - without a difference of opinion then there isn’t a market to trade.
Perception is reality and like the tulips imported from the Middle East in the 1600s, the perception (at the moment) is that these companies will blossom into the next Tesla success story.
So, what’s my take?
Just my opinion and should not be considered advice – but you’d never catch these companies in my portfolio. And I’m fully accepting that I’ll possibly have to watch others become exceedingly rich and equally smug while I stick to my tried and tested path.
I subscribe to Warren Buffett’s first rule of investing – never lose money.
Obviously, that’s a very tricky task. The very nature of trading is that for you to be right, someone needs to be wrong. But simply ask yourself, how much upside has been priced in vs the downside risk? Could this fall out of fashion and implode overnight? Am I buying fantasy or reality?
I should draw your attention to 2019’s forgotten flavour of the month – cannabis stocks. So much pomp and ceremony surrounded Tilray, Aurora Cannabis and Cronos Group. Where are they now?
Languishing at the bottom of an abandoned bullet board and their share prices, wilted.
Part of the trouble is, these companies make for a great click-bait write up. Do yourself a favour and Google any of the above-mentioned companies and try and find an article which makes a credible unbiased argument that lays out the risks or discusses the monstrous cash burn.
They serve to garner clicks and generate advertising revenue. ‘5 stocks which might make your wallet considerably lighter’ doesn’t quite have the same ring.
It’s normally at this point that I’d delve into some of the valuation metrics/balance sheet/cash situation, but it’s honestly a pointless task. There’s very little to build a robust investment thesis around at such infancy. They’re priced on future upside potential, projections, boardroom credibility, market size and hype.
I’ll stop banging on about the negatives now otherwise I’ll quickly put myself on a downer at this rate!
Bubble stocks are hands-down the best performing shares when they’re in vogue and, if you fancy a punt, can very quickly turn a dull portfolio into a bulging pot of uncrystallised wealth. If this is your bag, then your best outcome is that others continue to buy into the dream after you’ve staked your claim to a share of the company. So, go forth and tweet up a storm!
I think it’s a fair strategy to consider a high-risk trade which has 100% downside risk but several hundred percent upside reward. If you find yourself in the wonderful position of being on the upside of such a momentum play, remember what the risk to reward ratio was to begin with. A common trait for retail traders is to snatch a quick profit as soon as they see it. If you’re snatching quick profits while risking 100% of your capital, then you may need to look at how you’re managing risk.
Taking a profit is all well and good but if you’re repeating this process, then play forward a scenario whereby the share price goes down instead of up. Remember, if a share price falls 50%, it will need to rally 100% to get back to where you started.
I’ll leave you with one final thought. Any good stock picker who’s worth their weight in share certificates will always try and disprove their own idea. Identify exactly why it could go wrong. You should do the same.
With the current hype surrounding new EV market players, I can’t help but think – can’t the likes of Ford, GM, Mercedes, who trade at a significant discount, catch up on the electric market?
If you’ve enjoyed this article and want to start your investing journey, feel free to reach out to me personally on t.sunderland@mittomarkets.com or call +44 (0)208 159 8985
Important Notice: When investing in shares, your capital is at risk. The value of the investment and any income from it can fall as well as rise, so you may get back less than your original investment.