Many people look at Apple’s price history and assume that most high-growth, momentum stories have a similar path – up and to the right; always recovering from their dips. Nothing could be further from the truth. The momentum universe is full of stocks like $YELP – they go up several hundred percent in a short period of time, reflecting market’s extremely high and often irrational expectations. Then when the market wakes up from its dream and realize that those stocks are not the unicorns it imagined, they give back 50 to 90% of their upside moves.
We dive a lot deeper into this topic in out latest book “The Next Apple“.
Financial markets live in the future. They constantly strive to price events that haven’t happened yet. Sometimes, they are spot on and discount what will actually happen ahead of time. For example, housing and home improvement store stocks started to break out to 52-week highs in late 2012 – long before economic data confirmed that there’s a housing recovery in the U.S. The market correctly predicted what was going to happen. By the time it was clear that the market had been right all along, most of the upside move in homebuilders was over.
By pricing events that haven’t happened yet, financial markets will occasionally discount events that will never happen. Markets are not always right. A stock could quintuple based solely on investors’ speculations and expectations for future profits. For example, 3D printing stock DDD went from $ 10 to 100 between 2012 and 2013. At the time, the whole world was excited about the possibilities that 3D printing could bring to manufacturing. 3D Systems did not live up to the expectations. The market became tired of waiting for the company to start making real money, and it sold the stock off in 2014.
Short-term price moves are based on sentiment. Long-term moves are based on earning power. The story, or more precisely, the expectations about a company have to come true at some point. Otherwise, disillusioned market participants will start to sell. The market is not always a brilliant, forward-looking mechanism, but it’s also not stupid or naïve, at least not when given enough time. In short-term perspective, it could be all of the above times 10 and create results that are both irrational and unpredictable.