For Tech Investors, Momentum Is Not a Four-Letter Word
It’s terrible, this momentum game in the stock market.
Terrible, that is, for many investors who haven’t been along for the ride.
The momentum game unquestionably is a big part of what pushed the technology-dominated Nasdaq composite index past the 3,000 mark last week, and what has powered the average tech-stock mutual fund to a stunning 65% gain since Jan. 1.
But momentum investing, its critics say, is nothing more than bandwagon-jumping: A stock rises from $20 to $30, relatively unnoticed. Suddenly, many investors begin to pay attention. In a few days or weeks the stock is at $50. Now, seemingly everyone wants to own it. Next stop: $80, $100, $300--who knows.
And what has happened with the underlying business? Did anything really change in a matter of days? Probably not. The stock just got hot.
“Every dog has its day,” your grandmother used to say. And plenty of momentum stocks have in fact quickly hoofed it back to the doghouse on Wall Street after their 15 minutes or so of fame.
The Internet stock sector has been littered with such issues. One of the most infamous is K-Tel International, the music vendor that soared on two occasions in the last two years simply for making noise about selling its greatest-hits compilations over the Net.
K-Tel leaped from $4 to $32 a share in spring 1998, then collapsed. Last November, it rocketed again, from $7 to more than $30 in a few days, before quickly sinking once more. Today’s price: $7.88 on Nasdaq.
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Why do investors play this game? Because sometimes--many times, actually--hot stocks just get hotter, and stay that way for months and even years rather than merely a few days. Conservative investors still slap the momentum label on these kinds of winners, and insist that they’re ultimately doomed stocks.
But that is far oversimplifying--and it also amounts to some very sour grapes on the part of those on the sidelines.
More often than not, a stock gets momentum because there’s a buzz about the company. Its products or service may be in great demand right now, or there may be legitimate reasons to expect that demand could soar soon.
For investors, the challenge is translating the company’s sales and earnings potential into a fair stock price. But let’s face it: Even for well-informed analysts, this is ultimately guesswork.
The louder the buzz gets about a company, therefore, the more investors are willing to accept the most optimistic scenarios for the business in terms of deciding what share price is worth paying today.
That’s the fundamental basis for a momentum stock’s ascent. But there are, of course, many momentum investors who do little or no homework with regard to a company’s fundamentals. For this group, all they need to know is that the stock is rising. Someone else, they’ll assume, has done the homework and figured out that something potentially big is going on at the company.
Enter the “greater fool” theory of investing. Veteran investors know this game well, whether they play it or merely watch it unfold. For pure momentum investors who have no interest in truly researching a company or stock, the greater-fool theory is justification enough to buy.
Their motto: “I may be a fool for paying this price for the stock, but there is a greater fool out there who will eventually buy it from me at an even higher price.”
How else to explain the continuing price spikes of new Internet stocks on their first trading days, when investors who couldn’t get a piece of the deal at the offering price rush in to buy at whatever the market demands?
Hot Net-related IPOs are back in a big way on Wall Street, after demand faded somewhat in the late-summer market pullback.
On Friday, Cobalt Networks, a company that makes low-cost computer servers that are supposed to give small businesses an easy way to establish an Internet presence, began trading on Nasdaq after pricing its initial stock offering at $22 late Thursday.
The stock (ticker symbol: COBT) rocketed as high as $158 on Friday before settling at $128.13, up $106.13, or 482%, for the day.
No doubt many of the buyers Friday had no idea whether Cobalt is really the Next Big Thing--or just the latest K-Tel. But certainly, no one paid $158 a share because they figured that would be the peak for Cobalt, forever.
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Despite the seeming madness of this game, momentum investing, especially in the technology sector, has not been the inevitable fast road to ruin that its critics would like us to believe.
Consider the case of Qualcomm Inc. (QCOM), the San Diego-based company that has developed what many analysts expect will be the future standard for wireless technology in cellular phones and other devices.
Investors didn’t pay much attention in 1997 and 1998 as the company’s sales and earnings mushroomed. At the start of this year Qualcomm’s shares were priced at just $26 a share.
Now the stock is at a record $294.38. Momentum? And how! But when the price hit $62 by April, many investors surely thought, “That’s too much.” Others said the same thing when the stock hit $156 by August (and a price-to-earnings ratio of 126).
At nearly $300 a share now, who was the greater fool--the person who bought at $156, or the person who stayed away?
“Just wait!” Qualcomm’s detractors will say. The company has only begun to feel competition from Motorola, Intel and other giants. The stock will never sustain these heights, they say.
They may finally be right. But if the momentum buyers today have taken Qualcomm too far, those who played the game in the spring were recognizing that the stock’s potential was at that point greatly underappreciated by the market.
The same could be said about many other hot technology stocks this year--fiber-optics firm JDS Uniphase (JDSU), which has zoomed from $27 to $197 in 16 months; data-storage-management software firm Veritas Software (VRTS), which has risen from $25 to $108 in the same period; and computer networker Sun Microsystems (SUNW), up from $25 to $109 in that period.
Sun, in fact, has been a “momentum” stock for much of the last five years. Is this, finally, the peak? We’ll know only in retrospect. But even if Sun’s run is over, a horde of new tech stocks is certain to replace it in the momentum game.
The point is, when investors are hungry for growth stocks, what starts as a fundamental stock story can quickly become a momentum story--and continue for far longer than most investors can imagine. It takes guts to own such stocks--and to stay with them--but the rewards well explain why many investors are willing to take on the risks.
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While the headline-grabbing action has been in U.S. technology stocks, investors who own foreign stock mutual funds should be noticing that they’re quietly piling up profits in those securities.
In the five days ended Thursday, the average foreign stock fund rose 3.7%, according to fund tracker Lipper Inc. The average emerging-markets fund, which targets shares in the developing world, rose 5.4%. By contrast, the average diversified U.S. stock fund rose 3.1% in the period.
Likewise, over the last three months and year to date, the average foreign and average emerging-markets funds are trouncing the Standard & Poor’s 500 stock index.
Even an interest-rate increase in Europe last week didn’t dim enthusiasm for European stocks. Latin American stocks also surged.
The action in foreign markets suggests that optimism is rising about economic growth overseas in 2000. U.S. investors who have ignored foreign stocks in the 1990s ought to be paying attention.
Tom Petruno can be reached by e-mail at tom.petruno@latimes.com
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Foreign Stocks: Quiet Leaders
The U.S. market has rebounded sharply in recent weeks, but many foreign markets have risen even faster. A look at returns on key categories of stock mutual funds over the last three months and year to date:
Last 3 months
Avg. foreign fund: +9.4%
Avg. emerging-mkts. fund: +5.4
Avg. U.S. fund: +5.0
Avg. S&P; 500 fund: +3.9
Year To Date
Avg. emerging-mkts. fund: +35.1%
Avg. foreign fund: +18.0
Avg. U.S. fund: +11.7
Avg. S&P; 500 fund: +11.4
Note: Data are through Thursday.
Source: Lipper Inc.
