Posted By The Pitfalls of Fanatically Following the Stock Hype
By Steve Lowrie, CFA
Special to Financial Independence Hub
“There are recurring cycles, ups and downs, but the course of events is essentially the same, with small variations. It has been said that history repeats itself. This is perhaps not quite correct; it merely rhymes.”
Dr. Theodor Reik
It seems to me that the central tenet of the financial media (group-think central) is to glorify stocks or sectors that have experienced recent outsized returns. The hype of cult stocks extends and is amplified by social media channels and its various influencers. Ask any reputable financial economist about these past monumental gains and they will indicate that “past performance is not indicative of future returns.”
Despite the restrained advice of these financial experts, it’s easy to get swept up in the hype surrounding these popular stocks and investment trends. Some choose to surrender to FOMO (fear-of-missing-out) and follow these financial fads. for the chance of scoring a big financial win with a little excitement on the side. While these stocks may seemingly promise rapid growth, there are some obvious (and not-so-obvious) risks of chasing high-flying stocks.
It’s important to consider the other option: a more thoughtful, measured investment plan. Maybe not as thrilling, but certainly a better path to reaching your long-term financial goals.
In my experience, the greatest risk to someone’s financial well-being is not so much panicking and selling in a bear market (although that can be devastating), it is getting caught in up in a fad in an up market. Just look back at previous fads or bubbles like dot-com stocks (late 1990s-early 2000s), housing and mortgage crisis (mid-2000s), SPACs (2020-2021), and cannabis stocks (2018-2020), to name just a few. In all these cases, there are numerous examples of hyped stocks running up, but then going down 90% or worse. This is where we need to embrace the theory of history repeating itself to be alerted to the potential pitfalls of investing in cult stocks: they might bring the excitement but they typically underperform and create significant risk.
Let’s explore some examples of how some stocks can achieve a cult-like following and a take realistic look at how they could play out for some real-life investors.
Individual Stock with a Cult-Like Following
Looking back helps us see what is most likely to happen in the future. So, we’ll look at two individual stocks that ended up with a cult-like following.
By 2020, Nvidia was no longer just a stock: it had become a movement. There were legions of investors, bloggers, and social media influencers all singing its praises. You could barely scroll through an investment forum without seeing someone post about Nvidia being the future, with charts projecting its exponential growth.
Similarly, Peloton had developed a near-cult following. The company’s sleek bikes weren’t just fitness equipment: they were a lifestyle. And its stock wasn’t just an investment: it was a symbol of the new, post-pandemic world. As Peloton soared, so did the confidence of its investors, who believed they had found a company that was reshaping fitness forever.
But there are two major problems that plague hyped stocks:
- People start to believe that the company can do no wrong and that its growth is limitless. And they make investment decisions based on that ill-conceived confidence.
- Investors are real people with real emotions and real egos. Cult-like stocks can cloud judgment, leading to irrational decisions based on emotional narratives rather than rational analysis.
And that’s where the danger lies.
The Reality of Compounding and the Impossibility of Endless Growth
For those watching Nvidia and Peloton stocks with bated breath, it seemed like the stock would climb higher, feeding the belief that it would never stop. But here’s the thing about high growth rates: eventually, they hit a wall.
Let’s break it down: Nvidia’s market value today is about $3.4 trillion, and the entire U.S. stock market is worth around $55.2 trillion. If Nvidia kept growing at 32% annually while the market grew at a typical 10%, in less than 20 years Nvidia would make up 100% of the entire stock market.
That’s impossible.
No company can make up 100% of a market that includes every company. At some point, the math just doesn’t work. Yet in the heat of the moment, many investors don’t think about that. They were so caught up in Nvidia’s incredible growth that they assumed it could just keep going.
But in the stock market, what goes up can come crashing down.
When the pandemic waned and people started going back to gyms, Peloton’s sales fell. Its stock price, which had soared by 500%, tumbled by more than 80%.
What investors didn’t realize is that outsized returns like 32% annually for Nvidia or 500% for Peloton don’t last forever. No stock can keep compounding at such high rates indefinitely. In fact, the higher the growth, the harder it is to sustain.
For every Nvidia that defies expectations for a while, there are countless Pelotons: stocks that rise quickly but fall just as fast. The excitement and fervor around these “cult stocks” can make it easy to ignore the reality: high growth eventually stops, and the bigger the growth, the harder the fall when it comes.
The Emotional Trap of Cult Stocks
When a stock becomes a movement, like Nvidia or Peloton did, investors often fall into an emotional trap. They start to believe that their stock can only go up, and they cling to it even when the data suggests otherwise. This is where the cult-like following can become dangerous. It’s not just about numbers anymore: it’s about identity, belonging, and belief.
A hyped-up investor can come to believe in their stock so strongly that they willfully disregard data that suggests the stock’s looming downfall. And when the stock crashes, it can rock them to their emotional core.
In addition to emotional investing, ego can play a major role in financial decisions. Think about the talk around the office water cooler; it usually involves some light bragging about unimaginable investment gains on the hottest stock. But do you ever hear about the inevitable fall of those cult investments?
People are human. They want their peers to respect them and think they are brilliant. And it feels good to talk about their successes and impress their coworkers. Which makes it even less likely that they will cut their losses and have to admit an investment downfall. In fact, when there is a loss, it can often make the cult investor even more determined to regain their big wins.
Consider how behavioural finance theories impact our investment decisions; it’s such an important concept that we’ve written several blogs on the topic:
- Play It Again, Steve – Timeless Financial Tips #4: How to Manage Your Financial Behavioural Biases
- Behavioural Finance Focus: Cost Savings Tips to Attain Financial Freedom
- Q&A: What is behavioural finance: And what’s it to me?
Instead of focusing on individual stocks, smart investors build diversified portfolios, which mitigate the emotional highs and lows of stock performance and allow for participation in broader market growth.
The Tale of Three Investors
Let’s take a realistic look at how this could have played out for some real-life investors…
Meet Barry, Robin, and Maurice. They were coworkers at a mid-sized corporation. They had similar lifestyles and investing background/goals:
- Age 45 – 50
- Married
- 2-3 kids, aged 13 – 23
- Senior manager or director at their company
- Accumulators: they had made significant progress towards their financial goals but were considering their options to kick it into a higher gear Continue Reading…
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