Let’s analyze the transactions in the portfolio of a famous mathematician and physics genius. He allegedly bought a company in March for $200 and sold it in June for $600, thinking the price was unwarranted. So far so good. However, seeing that the stock price increased and while under pressure from his friends, he then repurchased the stock at $1,000 in August. Finally, he decided to sell his entire position at $100, a bargain considering that the stock price is currently at zero.

 

Not so great for this mathematician after all right? We're talking about a loss of $3 million today! This is a sad, but true story. It dates back to the year 1712 and relates to none other than Sir Issac Newton, the father of modern physics!

 

What is ironic here is that Newton discovered the Laws of Motion. Some not so creative Economists, were inspired by his work to describe an equivalent phenomenon in the financial industry: People like to buy stocks that perform well and their purchases, in turn, fuel the price increases of those securities. This reality is called “Momentum” investing. Newton, therefore, was a victim of the same game he described in his books.

 

A lot of times people tell me about a stock their neighbor (or worse, their brother-in-law!) owns. They describe how its dramatic increase must be a guarantee of its quality. In their defense, there is always a grain of truth in the rise or fall of the stock market. But as Howard Marks often repeats: "What the wise do first, the fool does last."

 

That's when I bring them back to reality and remind them that behind every stock price, there are company fundamentals that must be considered. We must not forget that it is the quality of the company that determines its long-term performance. The price paid for it does not change your risk or your chances of success. The price simply changes their own success of the investment.

Throughout the last few months, the “Momentum” of certain stocks reached record levels. Take for example Apple which has appreciated by more than 40% in 2 months! This increase occurred after the company announced its stock split. This is the equivalent of changing $1 for four $ 0.25. I will keep this event in mind for the next time I hear about efficient and reasonable markets…

 

When a stock is increasing based on “Momentum”, I like to tell myself that trees don't grow to the sky. These days I tell myself that while Newton understood physics and gravity, many investors like him have been hit with an apple on the head.