What Are Investing Fads?
Investing fads are popular stocks or other investments that enjoy substantial short-term gains. Investing fads are normally characterized by a temporary excessive enthusiasm for a certain investment or style, which is by definition unsustainable over the long term.
The dotcom bubble was an example of an investing fad in which investors were more inclined to purchase a stock if its business had even the slightest exposure to the internet. That fad ended when the dotcom bubble burst.
- An investing fad is a temporary run up in a stock or other asset driven primarily by market enthusiasm and is not sustainable over the long term.
- Fads differ from trends that are based on solid underlying fundamentals and can produce strong performance over a longer term.
- Distinguishing between a fad and a trend is a difficult challenge but can prove to be highly profitable.
Understanding Investing Fads
Investing fads are sometimes confused with trends, but there is a major difference. Trends persist over the longer term and are usually based on fundamentals, whereas fads often die down after a shorter period. When investing, it is helpful to understand whether you are participating in a fad or a trend. For investors who know when to get in and get out, fads can provide a portfolio boost. However, if investors get caught up in the hype, they'll likely lose money when the fad dies.
While fads are easily distinguishable from trends in retrospect after the fad has failed, in the moment this is often not the case. Once the fad is over, then of course hindsight is 20/20. However, during the run up in a stock's price, whether the gains are a sustainable trend or a short-term fad is always an open question.
Example of an Investing Fad
A great example of a fad is the company Crocs (CROX), which went public in 2006 at $21 per share. The maker of rubber shoes enjoyed great success as the demand for sandals expanded from a boater's or gardener's shoe to acceptable everyday footwear. Everyone from kids to grandmas were wearing the comfortable and eye-catching sandal.
The hype was extremely positive from the time the stock began trading publicly. Quarterly sales often grew by triple digits. In October 2007, just 20 months after going public, the stock rose to more than $70 per share. On October 31, 2007, the company reported quarterly earnings that saw revenue increase by 130 percent. But after making such a dramatic move higher, the revenue gain was not good enough for investors, and the stock began a protracted decline to a low of around $1 in November 2008.
Making Money on Investing Fads
Money can be made on fad investing, but timing the purchase and sale of the stock is key. From an investment standpoint, the entry point is extremely important because a fad can move from an unknown to the stratosphere in a short period of time. The best chance to make money on an investing fad is when and if it becomes an investing trend. Both fads and trends tend to begin in similar places with lots of hype.
The key to determining which direction the company will take depends on the viability of the product and the willingness of the company to adapt to changing market demands. Thus determining if a fad has the potential to become a trend requires a great deal of research and insight into a given industry and a company's place in it.