If you're at all interested in the stock market, you have at least once been in a situation where someone has given you some "information" that is not widely known.
You know what I mean, don't you? You're hanging out with the boys at the quilting bee and one of your buddies says, "You know what I heard about XYZ company," and it's invariably something that the market doesn't know about that is going to make the stock go absolutely crazy.
In my position, I receive "hot tips" every single day. I have an inbox full of messages from people letting me know that one company or another is about to take off because of a new product, a new initiative, a merger potential, or some other pie-in-the-sky reason. Do you think these cold-callers are writing me out of the goodness of their hearts? No, not at all. That's not the way the game is played. I receive this information -- good or bogus (mostly bogus) -- because people believe that I can help them if I write about the company.
This is not to say that I don't appreciate information and tips -- I do. It's just that I'm very suspicious of claims that are not independently verifiable, and I'm always cautious if I'm unfamiliar with the person providing them. I'm just, you know, realistic about what I'm reading or hearing.
Bad math, bad plan
Of course, most of the time these days, hot tips don't come from Cousin Eddie; they come in the form of emails and press releases from tout services. I received a particularly funny one this past week: a stock promoter called OTC Financial Network sent me an email about a Canadian company called On The Go Healthcare, a maker of baby products -- including potty training seats -- and a computer products reseller (a perfect synergy if there ever was one). This particular email noted that the company was "poised for rapid capture" of the $30-$40 billion baby products market. Later on in the same document the market is revised to $10-$25 million. This market is extremely competitive and well covered by, among others, the folks at RC2
A quick search shows that the company claims C$30,000 in sales a year ago, and C$185,000 this year. That's a great gain, but 6,150%? Try 615%. Not only did the company make a math error that should have been obvious the second they made it but also the company and its paid promoter have repeated it over and over and over in additional press releases. Not only this, but also touting such a number, even if the math were right, would seem to give the impression that this was organic growth, the result of a rapid acceptance of On The Go's baby products. Not so much -- the company made an acquisition of Vita Baby. You don't say 6,150% growth unless it really is 6,150%. You don't say 615% growth unless you stipulate that the numbers aren't comparable, because they're not. Here's something else none of these releases manage to mention: the company's staggering operating losses.
Ah, but I digress. Anyone who runs out and buys based on the recommendations they receive from paid stock promoters deserves the inevitable stream of red ink in their portfolios. But I suspect that many people can see through these things. What is harder to see through is the hot tip from the trusted friend, colleague, or family member. There are the serial hot tippers who always have something new cooking, some knowledge of some small technological marvel that is going to be the big one. I'm not talking about this guy (and isn't it almost always a guy?). I'm talking about your level-headed chum who once in a blue moon starts a conversation with "you know what I heard?" Your defenses are down. Suddenly, you're ready to believe.
The stone cold lock
About eight years ago, a friend of mine told me that he had heard rumors from credible insiders that consumer electronics manufacturer Zenith was going to be acquired. Knowing and liking this guy, I started looking into Zenith. But then I stopped to think about it: If my friend, who had no real connection to Zenith or its industry, "knew" that Zenith was in merger talks, then who else knew? And if so many other people knew, then wouldn't the price reflect this knowledge? And in fact, Zenith had risen some 15% in the previous weeks. I have no idea whether there was a connection between this rise and the rumor, but I knew at the time that I had no way of either verifying the information or figuring out -- if it was even true -- what it was worth above the current share price. And so I passed. Zenith ended up being acquired three years later by Lucky Goldstar at a fraction of the price it had been at when my hot tip came along.
I know my friend wasn't trying to put one over on me. He really, really thought he had a great tip. That's what makes such things dangerous. As far as you're concerned, the source is reputable. But unless my pal woke up one morning and decided over his Cocoa Puffs to make up a rumor on some company he didn't have anything to do with, he wasn't the real source. That came from elsewhere. It could have come from anywhere.
The twist here is that occasionally hot tips you receive turn out to be accurate. This doesn't mean that you should chase all of them hoping for the one. That's not investing; that's more like burning your money in a particularly optimistic way. If you have no way of verifying either the rumor or the origin thereof, it is best to let those "opportunities" slide. If, however, you can verify a rumor, then you've got something else, known as asymmetric information. That is a different thing entirely. It is also, for most individual and even most institutional investors, an exceedingly rare occurrence.
Want to read more on the nefarious forces that try to separate you from your investment resources? See also:
- Bill Mann's Hype, Spam, and Penny Stocks
- Zeke Ashton's Buy This Penny Stock!
- Jay Perlman's Same Scam, New Medium
Each month, our Hidden Gems analysts comb through the financials of companies out of the common view, they talk to investors and management alike to ferret out asymmetric information that they can bring to their subscribers. Interested in taking a look? Take afree trialtoday.
Bill Mann doesn't have a Cousin Eddie, though he did once dress up like Cousin Eddie for Halloween. He owns none of the companies mentioned in this article.