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Be Wary of Overhyped Stock-Market Darlings

Over my 14 years of investing, I have come across many cases of overhyped companies that hogged the media spotlight, yet ultimately failed to deliver on their lofty promises. As investors, we need to be aware of such cases, and be able to think rationally about a company instead of buying into the hype.

The danger of believing such hyperbole is that we may get sucked into an investment with the perceived promise that it will never go wrong, only to be flabbergasted when the company turns out to be the opposite of what it claimed to be. Here are some things investors need to take note of.

Why all the hype?

There are a few reasons for hype-generation, the principal one being that a company has an agenda to push up its share price, perhaps in order to do issue shares at a good price to raise funds for growth and expansion. Other reasons why there may be hype over a company include: management trying to increase overall awareness of the company’s merits; the company being in a promising, high-growth industry; and analysts from brokerage firms issuing glowing reports on the company”

All of the above reasons could create strong demand for a company’s shares as more and more investors get sucked into the hype and pile in.

How should we react?

We should react warily to hype and be on our guard. The problem with hype is that it commonly generates an emotional response, and it’s easy to get sucked in because of the FOMO (fear of missing out) mentality. FOMO results in a vicious cycle: As more investors pile in, the company’s share price increases and validates their initial decision, which then causes even more capital to flow in at ever-higher valuations.

Be cautious of valuations and business reality

When approaching overhyped companies, we need to take everything in with a huge dose of salt, as management and the media may play up only the positive aspects while downplaying the negative ones. As a result of the hype, such companies may also be trading at lofty valuations that are divorced from business-reality. The best thing for us to do is avoid such companies and observe them from afar.

The Foolish bottom line

From my personal experience, stock-market darlings are usually perceived to be able to do no wrong. This is a dangerous assumption, and a fallacy, and it should put us on immediate guard. Remember to always question if an investment idea makes sense before committing your money to it.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.