Cult Stocks: How to Avoid a Bad Ending

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Cult stocks shave been around in the financial market for as long as I can remember. These stocks attract unusual fierce allegiance from owners and equally vehement opposition from short sellers. They usually have some popular new product or service that is typically described as being "game changing" or "revolutionary." The debate between buyers and sellers of these stocks is far more vocal and strident than the usual genteel Wall Street discussion of the merits of various investment opportunities. And most of the time, like all cults, the end result is less than positive for the enthusiastic bulls of these stocks.

My introduction to the world of cult stocks literally came on the first day of my brokerage career at Dean Witter Reynolds back in the 1980s. Right before I started, the company had been the lead underwriter on a revolutionary new toy company -- a hot stock that quickly developed a cult following. The fact that Dean Witter was the lead should have been a clue for most investors. There were a lot of things the old retail firm did well, but investment banking was not one of them. The company in question was Worlds of Wonder, and the product, of course, was the talking teddy bear, Teddy Ruxpin. It was, indeed, a great product, but I have always suspected the bear knew more about manufacturing than the company did. The company eventually floated a junk bond that Dean Witter brokers eagerly pushed to starry-eyed clients. The company never made a single coupon payment and ended up bankrupt, taking all of the enthusiastic Teddy Ruxpin fans with it.

The Internet bubble in the late 1990s was one giant cult, in my opinion. Dot.anything could issue stock and triple in the first day of trading. I can remember arguing endlessly with the frenzied buyers of these companies about the merits of paying 40x or 50x sales for a company. I got so tired of being told that I just did not understand the new paradigm and the true impact of the Internet revolution. I can remember almost coming to blows with another broker about the absolute idiocy of paying the current valuations for stocks like Netscape and America Online. The man was a deacon in his church, but was willing to engage in a fist fight to defend his revolutionary stocks. The last two years of the Internet boom were Kool Aid drinking of the finest financial kind, in my opinion.