Shun The Overhyped Stocks!
Avoid investing in overhyped stocks is what the year 2018 taught us. Yogesh Supekar and Karan Bhojwani discuss what exactly are overhyped stocks, how to identify them and how they have fared in terms of their fundamentals
Any investor who has spent a decent amount of time in equity markets would have noticed that stock prices move up when profit increases, balance sheet gets stronger, margins improve, debt gets reduced and sales grow at a faster clip. It is only logical to expect the prices to go up when such fundamental triggers are available for any stocks.
"Often investors wonder why those stocks
that should be down and out are flying and soaring high,
while those that should be gaining (quality) are staying flat"
Also, it is quite possible that you may have seen stock prices soar even when the earnings are flat, balance sheet stands unrepaired (higher debts), promoter shares are pledged incrementally, margins are struggling to improve and sales de-grow or slow down.
The stock prices take cues from improving or deteriorating fundamentals, alright, but at times the share prices are determined purely on the basis of the popularity of the scrip. The more popular a stock is amongst the investors, the more the demand for the shares! Thus, in practice, the market tends to value stocks based on their popularity and not merely on their fundamentals.
The reality is, in the equity markets, both the scenarios exist and, as a smart investor, you just have to avoid being caught in the hype of the popular stocks that are not supported by fundamentals. The more intense the popularity contest gets for the stocks, more and more investors are found investing in these so-called popular stocks or “overhyped stocks”.
The year 2017, which was a great year for investing, saw investors flocking to invest in overhyped stocks, only to realise that these set of popular stocks were not supported by fundamentals to back the high valuations commanded by them.
What are overhyped stocks and how did they perform recently?
Overhyped stocks or popular stocks are the ones which are popular among investors, primarily retail investors. Some of the characteristics of overhyped stocks are :-
1. Overhyped stocks show huge price pop ups with flat earnings per share.
2. There is a significant price rise in these stocks without any matching surge in volumes
3. Chances are that these overhyped stocks outrun their fundamentals, i.e., a stock may be fundamentally strong but its popularity makes the valuations unjustifiable.
4. Mostly, the news related to these stocks is PR driven and has little relevance to the earnings
5. In a bull market, investors tend to invest more into equity markets while the list of quality stocks available in such a scenario does not expand. In such a scenario what happens is that more money chases few quality stocks that are available. Investors invest via MFs - SIP (Systematic Investment Planning) and fund manager deploy this cash into equity markets, thus pushing the valuations much higher than they deserve. This phenomenon drives several stocks into the overhyped zone.
What is interesting to note in the table above is that the profits, sales and EPS grew for a majority of the popular stocks. However, the stock price rise was way too fast for all these stocks and higher than the improvement in the fundamentals seen in these stocks. For example, Vakrangee's sales grew by 57 per cent in the four quarters in CY17, however the stock price rose by 208 per cent in CY17.
Rain Industries' sales grew by 24 per cent and declared profits increased by 391 per cent; however, the share price rose by a whopping 667 per cent in CY17. For Dilip Buildon, the sales improved by 11 per cent in four quarters in CY17 while the profits dwindled, however, the stock price soared 330 per cent in CY17.
If we consider the average performance of all these overhyped stocks, we find that these eight popular stocks on an average delivered a mere 23 per cent rise in sales and an impressive 83 per cent rise in profit after taxes, while on an averagem the stock prices increased by 283 per cent in less than one year. If we remove Rain Industries from the list, the average performance of the popular stocks suggests that the sales grew by an average 22.8 per cent for the set of 7 popular stocks, the profits grew by 39.4 per cent, while the share prices rose by 229 per cent on an average.
This goes to show that the stock prices of popular stocks clearly outrun their fundamentals. While this was happening, several investors were caught on the wrong foot as they speculated that the dream run will continue for these stocks. During the same period, there were several stocks that displayed better sales growth than the overhyped stocks and yet these stocks did not show as big a jump in share prices as was witnessed in the overhyped stocks.
The stock price and sales growth relationship is worth noting in quality names such as Bajaj Holdings and HDFC. The stock price jumped 56 per cent in less than one year in 2017 in spite of sales growing at an impressive 76 per cent in four quarters in 2017.
We can say that stocks like Kaveri Seeds, Bajaj Holdings and HDFC are not examples of overhyped stocks and are backed by quality fundamentals.
What happened to these overhyped stocks in 2018?
The same set of stocks that created wealth in 2017 for investors destroyed their confidence in 2018. On an average, the profits declined for the popular stocks by about 45 per cent, while their sales declined by 7 per cent and the stock prices tumbled by 60 per cent in one year, i.e CY18.
The profit declined by almost 99 per cent for Vakarangee, by 48 per cent for Avanti Feeds,by 40 per cent for Rain Industries and by 49 per cent for Dilip Buildcon in fours quarters in 2018. The share prices were seen cracking throughout the year for these overhyped stocks. Edelweiss is an exception with its profits increasing in 2018 and yet its stock price correcting – in line with the sectoral (NBFC) performance.
Overhyped stocks usually trade at a very high P/E ratio :
Identifying overhyped stocks using technical analysis:
One of the methods to identify whether a stock is overhyped and not backed by fundamentals is to identify charts where the stock price is soaring, but the price movement is not supported by the volumes. The lack of volumes in the counter is an indicator of an overhyped stock.
Overvalued stocks that may probably join the list of Overhyped Stocks of 2019
Several stocks are running ahead of their fundamentals in the current market. Rising stock prices that are not backed by rising volumes are a cause of concern for the sustainability of such a rally. The list below represents stocks where the prices have spiked rapidly without much support from trade volumes and hence investors should be careful while investing in them for 2019. Investors are advised to stay away from tempting spurts in stock prices in the near-term and should rather focus on fundamentals questioning whether the sales growth and profitability of these companies are sustainable, going ahead.
Gaurav Bissa
AVP-Technical and Derivatives, LKP Securities
What are common characteristics or signs of overhyped stocks?
A sudden surge in volumes, although the delivery percentage may not be high. These stocks can trade in either overbought or oversold zone for an extended period of time, while incremental volatility is a common trait
Why is it that investors and traders are attracted towards overhyped stocks? The most important factor is greed, which comes from the 'left out' feeling. Traders have a chance to make decent money if they catch the trend right, as once they pick a trend, it can continue for a while
Profit-booking is essential objective of investing. What technical parameters are vital for an investor to look at while booking profit in overhyped stocks? Volumes play a crucial role..If the price goes up in the absence of volumes, it would generally mean the rally is hollow. On the other hand, if the stock comes down with rise in volumes, it will provide first sign of people exiting the stock and it is prudent to book profits in such a scenario. One can use trailing stop loss to protect from the potential fall in the stock
Conclusion:-
While constructing a portfolio, investors have to bear in mind that the stock price goes up not only due to fundamental or logical reasons. At times, the stock price soars in spite of the stock not being a quality stock. Investors have to identify such stocks that are running ahead of their fundamentals. Unfortunately, there is no provision for Indian investors to short sell shares on a delivery basis in the cash segment.
This facility would have presented investors an opportunity to borrow shares which he or she thinks are overvalued and make a profit by selling first and then buying them at a later date. As short selling is not an option for investors at large, the best thing that investors can do is to avoid such popular or overhyped stocks.
It is a reality that contradiction exists in equity markets and every investor has to deal with it. The ones who understand this market contradiction are the ones who can make money in the markets. Not all stocks that soar in prices are good for investments. Investors time and again have failed to understand this very simple reality of the equity markets. Hence, they are trapped into investing in popular stocks. Investors chase returns and outperforming stocks and ignore quality and future outlook. The huge demand for the popular stocks takes the valuation of the stocks to unsustainable levels, followed by sudden and drastic fall in these stocks.