Monday, April 28, 2008

Analyzing Investment Hype

There is a lot of hype in the investment world. Here is a good example:

It appears that this newsletter author has some interesting ideas about how to filter through the mass of penny stocks available and choose ones with a decent likelihood of gaining value. I don’t object to this kind of analysis. It’s the kind of filter I would expect to be employed by someone publishing an investment selection newsletter. I do, however, object to some of the language used to market this opportunity.

Here are a few words used in this advertisement that I think are telling:

  • “Scientifically selected:” What does science have to do with selecting stocks? Scientific experiments require control groups that allow scientists to observe behavior when specific variables are changed. In that way scientists can make theories about the effect each of these variables has on the outcome (results). Looking at historical numbers of stock prices incorporates so many variables (buyer psychology, societal values, access to capital, other investment alternatives, inflation, etc.) that it would be nearly impossible to control for even a few.

  • “Winnings:” This word implies that you aren’t earning a return, but hitting a jackpot at the casino. Part of me wonders whether this was careful calculation on the part of the author and his attorneys in case an investor ever takes them to court for misleading claims of returns.

  • “Theoretical:” Using historical performance to build models for predicting the future is not a new concept, but it has hardly proven successful over the long run. This author is clearly communicating that there wasn’t an actual person turning $200 into $1.2 million. Rather, this is an example of what an investor could have done with perfect foresight.

  • “Ordinary investor:” This implies that you don’t need to have any experience with or knowledge of penny stocks. Rather, by just following this author’s monthly recommendations, you can make these huge returns. I understand that risk disclaimers do not make effective marketing material, but I doubt this author will take liability if the investments don’t pan out. Oh, and it’s helpful that “ordinary investors” typically do much less due diligence about claims of returns than “extraordinary investors.”

For the record, I’m always wary of promoters that advertise such high potential returns. If this author were assured of his ability to double money in six months, he would be working adverse to his own economic interests by sharing this information. While I’m all for believing there is some altruism left in the world, I haven’t seen many instances of people not wanting their fair share of value they help create. This author, if his claims are correct, would do much better to start his own hedge fund and rake in billions in profits and bonuses risking other people’s money. The fact that he is writing a newsletter instead makes me a little skeptical.

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