Back to Basics (2)
In my first foray into this blogosphere, I reminded myself (not sure how many others read, let alone agreed with it), that the markets are often more influenced by emotions than facts. Today I want to go over other fundamental emotions.
The essential underpinning of any stock market is; that a company, due to growth or desire for growth needs capital. One of the avenues available is to allow the public to by shares in the company. The investor would buy shares in a company because he believed the company's business model made sense. In turn this would cause the company to grow and prosper. This enabled the company to repay the investor, through a share of the profits, called dividends.
When ever this equation breaks down and there are no real profits in the company, some form of a bubble is likely to form. Why would I give money to a company that is losing money and thus unable to pay me back?
Two possible reasons, one I hope in the future they will become profitable and be able to pay me back. ( the higher the risk of them not paying me back, the higher the profit I expect when they do in fact pay.) The second possible reason for investing in a company losing money is akin to a form of a "Ponzi" scheme, this is where I hope to sell my shares at a higher price to the next person in line, not because of fundamentals but because they in turn hope to do the same.
Both of these reasons seem highly risky to me. They're both based on a hope that some future event will happen that will allow me to regain my capital. I see so many other investors making money and lots of it, that I don't care if it makes sense or not, I want to make money as well. My greed feeds my hope. The theory of cognitive dissonance, will often cause me to post- fact justify, why I invested in a company that wasn't making profits. We witnessed this during the dot.com bubble where Priceline.com had a higher market cap, than some of the actual airlines you were using it ,to book on. Analysts justified it buy saying there would be a new economy … not pretty when the bubble burst.
Despair is the other side of this coin . This is wear even though the fundamentals of a company are good. One despairs of the stock price ever reflecting these fundamentals. For instance, in the aforementioned bubble-burst a company like IBM was also severely punished despite the fact that it was actually making a good profit.
Hope and Despair two emotions we should be aware of, especially in these turbulent times