Electric vehicles represent a large part of our future; however, not all electric vehicle stocks are going to be worth an investment. Just because there is a great deal of hype and excitement about a particular technology, and it has recently gained momentum, does not mean that it will necessarily be a good buy. In some cases, they will be an opportunity for investment; in other cases, they may simply be indicative of a “bubble” that is about to burst.
Many investors learn this the hard way, and it is an uncomfortable truth.
One of the patterns observed over many decades in the stock market has been that there are times where people become obsessed with a particular technology, such as a coinciding cycle: people talk about the future, investors run in to invest, prices increase exponentially due to heavy demand, and all of a sudden, everyone wants to get in on the action; then, at some point, the reality catches up with investors and everything comes to a screeching halt.
We have seen this play out before in the Nasdaq market:
- The reasons that this pattern is so interesting is that while there may be a “bubble” with respect to the technology, both the excitement surrounding the technology, and the technology itself, will continue to be around long after the equities have completed their ascent);
- The Internet had value, tulips had value, and electric vehicles most definitely have value; however, the problem is that everyone generally overestimates the speed with which an investment will yield a return once it becomes a valid technology.
That’s Where Things Get Ugly
The Two Ways Investors Typically View Stock Prices
When it comes to determining whether or not to purchase a stock the two types of mindsets people utilize can be broken down into two basic categories.
First Mindset: The Real Worth Of A Company
Investors evaluate the earnings, potential for growth, dividends and future earnings of a company in order to assess what the stock should be worth. As an example, if an investor determines the true value of a company’s stock to be $20.00 and it’s currently selling at $15.00, then it is a good buy. Conversely, if the stock is trading at $25.00 while its estimated value is only $20.00 (or less) then it is a poor investment.
This method is based on logic and financial metrics.
Second Mindset: The Psychological/Behavioral Aspect
An investor will typically base their valuation of a company’s stock on what another investor will pay for that stock at some point in time in the future. If an investor believes that the price will go up, they will purchase the stock in expectation of being able to sell it at a higher price later. As more and more people buy the same stock at the same time overall demand for the stock increases thereby driving the price higher.
This method is based on psychology and herd mentality.
At the same time that both scenarios are happening and being presented to the public, the price of a stock may go up or down unexpectedly.
Tulipmania And The Lesson Of The Internet Bubble
In the 1600’s many of the people of The Netherlands went through a period where there was great interest in tulips, however not common tulips, but rather uncommon, exotic and colourful tulips. Because of the large demand for these rare varieties of tulips, prices quickly rose.
A great deal of money changed hands during this period, with many buyers purchasing tulips for large amounts of money. Buyers would frequently trade their land, household items and personal items, fully expecting that the prices would continue to rise indefinitely.
The tulip speculation frenzy reached a level where it was completely out of control.
Eventually, the market got to a point where buyers decided to stop buying tulips.
When the buyers left, the tulip market collapsed, resulting in prices falling virtually instantaneously and the tulips becoming worthless.
When prices are based primarily on “excitement” instead of on actual value, the price declines can be very severe.
This lesson has been repeated multiple times, for example, the same general phenomenon occurred during the Internet boom in the 1990’s (and it has happened many other times throughout history, e.g., the Dot Com Boom).
The internet was obviously going to disrupt the world and savy investors agreed. Investment flowed into internet companies (especially those that contained the term dot-com in their title), resulting in a huge influx of capital into brand-new companies with very little to no profit history, with all executed on the premise that the future was bright.
This increase in investment caused a drastic increase in the stock price of many of these internet companies, which resulted in increased levels of trading, an explosion of media coverage, and a general feeling across the board that the public was now part of a financial revolution.
Then, the euphoria of the market faded as many of these companies turned bankrupt, and even companies that were considered to be performing well lost tremendous amounts of value. The market corrected, and ultimately the “dot-com” bubble burst. The internet survived, and in fact, flourished, however, there were many people that lost money during the period of market correction.
Why Electric Vehicle Stocks Feel Similar
Now take a look at the electric vehicle industry as of today.
The excitement around aspects such as clean energy, sustainability, and the future of transportation is phenomenal. Governments are embracing this trend, investors are highly interested in it, and new electric vehicle companies are popping up everywhere. The stock prices of many electric vehicle companies have increased several times over, with little or no profits to date.
Some electric vehicle companies are not even producing any vehicles and their stock prices continue to rise.
There has been a large influx of new investors into the stock market due to the easy availability of trading apps, the plethora of success stories on social media, and the accessibility of trading stocks. All of these factors are creating a perfect storm for speculative investing due to the technological capabilities, the excitement from the general public, and the simplicity of investing.
This type of activity resembles many of the other bubbles that have occurred in the history of the stock market.
Not exactly but very closely resembling.
I don’t know if they will all turn out the same way, but there are enough similarities that they make me wonder.
The Danger of Expectation versus Reality
The biggest danger associated with growing industries probably isn’t the technology; it’s the expectations created through marketing.
Electric vehicles are an important part of the future; there is no question about this. However, the problem is that the stock prices at this moment most likely reflect the future growth of electric vehicles for the next few years or even decades.
If expectations get too high, then stock prices can dissociate from the performance of the actual business.
When this occurs, it is fairly common for well-performing businesses to see their stock price fall relatively quickly when the market does its “self-correcting” process, leaving those investors who got into the stock market late stuck owning overvalued stocks that will take years before they see any kind of return on their investment.
This is the downside of investing based on hype.
Early investors benefit while late followers are penalized for following the crowd.
A More Deliberate Approach Is Often Preferable
Many knowledgeable investors prefer to be patient rather than jump on fast-moving market sectors.
They take time to look at the underlying fundamentals of the companies, consider the long-term potential for profitability, and wait until the company’s stock price offers an appropriate value before buying. While this strategy may seem slow in comparison, it helps keep investors from getting swept into waves of speculative mania.
The market moves in cycles, and excitement will eventually subside.
If a company makes it through the cycle, by then there will be new investment opportunities for investors to take advantage of when the stock is more reasonably priced. Therefore, even if investors miss out on the initial euphoria of a stock, those same shares could present a future investment opportunity for them to participate in.
Many times, your best investment decision may be to sit back patiently.
It is highly likely that electric vehicles will be part of the future of transportation, but it is difficult to predict which of the companies involved with EVs will be successful. Historically, new technologies create excitement and drive up stock prices until the hype becomes unsustainable and goes into a speculative bubble.
When considering whether or not to invest in stocks, an investor’s main focus should be on the underlying value of the stock compared to the market hype surrounding it.
If a stock is in an upward trend, backed by solid fundamentals, then an investor may want to consider purchasing the stock. However, if a stock is experiencing a rapid increase due primarily to speculation, then an investor should be cautious with that investment.
Investing is about being rational with your decision-making regardless of how good it feels at the time that you make that decision to invest when there is so much excitement surrounding the stock.
