It’s easy sometimes to get caught up in market opinions and forget one of the most fundamental reasons for investing in any asset: buying now with the expectation that someone will want to buy it from you in the future at a greater price.

Beware of analysts pushing stock… and monkeys

It sounds simple enough, but what’s easy to forget is that the price of any asset (real estate, antiques, etc.) is set by markets, not by what you personally believe it’s worth.

Financial instruments such as stocks, commodities, bonds, and their ETF proxies should also be approached with the same level of diligence – that is, to understand what the current drivers are behind prices, and to know how much other investors will feel they are worth in the future.

To answer such questions we rely on a number of widely accepted indicators, such as corporate earnings, advertising, our own greed and instincts, or perhaps what our peers and family members happen to be buying at the time. Many fortunes have been made by this method, and many more have been lost. More disturbingly, a good number of analysts exploit this and write up feel-good stories to convince people into thinking assets will appreciate in the future, right or wrong.

This is especially true with a stock like Facebook. It seems that investors have extrapolated company’s earnings trajectory in a straight line, and have made some assumptions about those earnings in the future to come up with the current stock valuation.  Furthermore, a number of analysts – mostly on the sell-side – have upgraded Facebook’s target price since the stock hit $50 last month.  It’s a typical tactic we have seen many times, where the largest institutional owners of a stock ‘talk their book’ and push the momentum further into the direction they would like to see it go, and this seems to be happening with FB.

There are many reasons why this happens, but it reminds us of an old parable (author unknown) that has made the round in financial circles:

“Once upon a time in a village, a man appeared and announced to the villagers that he would buy monkeys for $10 each. The villagers, seeing that there were many monkeys around, went out to the forest, and started catching them. The man bought thousands at $10, and as supply started to diminish, the villagers stopped their effort. He further announced that he would now buy at $20.

This renewed the efforts of the villagers and they started catching monkeys again. Soon the supply diminished even further, and people started going back to their farms. The offer increased to $25 each, and the supply of monkeys became so little that it was an effort to even see a monkey, let alone catch it!

The man now announced that he would buy monkeys at $50! However, since he had to go to the city on some business, his assistant would now buy on his behalf. In the absence of the man, the assistant told the villagers, ‘Look at all these monkeys in the big cage that the man has collected. I will sell them to you at $35 and when the man returns from the city, you can sell them to him for $50 each.’

The villagers rounded up all their savings and bought all the monkeys. Then they never saw the man nor his assistant, only monkeys everywhere! Now you have a better understanding of how the stock market works.”

To be a successful investor you need to be the first to identify a burgeoning market in monkeys and be one of the first to round them up.. but you also need to avoid being one of the last to sell them. To do this consistently and with confidence requires and investor to be true to their own convictions… what helps with that is an understanding of how markets work and the mechanics of the trends that fuel them.

In the case of Facebook, as the company’s fundamentals solidify from quarterly earnings to earnings, the price appears to be the result of euphoria we are currently seeing in the social networking sector.   In short, these days Facebook seems to be less in the social networking business as it is in the story telling business – a key factor in our previous analysis of the ‘perfect storm’ of Facebook’s upward momentum.

While this may resonate with some investors and intraday traders, this is not our style, nor is it a statistically efficient way to invest.  We reiterate our caution with stocks that are fueled by such momentum, as the upside can quickly turn to the downside without much warning.