Why Smart Investors Avoid Hot Stocks
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If you’ve spent any time with your attention on the market, you’ll already know that most people are naturally drawn to stocks that are already successful and popular with the herd.
There’s just something about the bandwagon that feels safe. With it, there comes a sense of: if everyone else is doing it, how could it be wrong?
But as William Green warns in Richer, Wiser, Happier—one of my favorite investing books—if a bright future is already reflected in a stock’s share price, then it’s probably “a bet for suckers.”
With that, the question worth asking here is: Why are most people drawn to the “it” stocks of the moment—the ones that have already seen share price success?
Well, at its core, it’s just human nature. We are hard-wired to follow the herd because survival depended on it for most of history.
There is strength in numbers. When faced with uncertainty, whether in life or in the stock market, sticking with the crowd feels like the less risky choice.
Beyond that, humans are also hard-wired with the fear of missing out. When we see others—friends, neighbors, even strangers on social media—making money on a high-flying stock, it triggers something inside of us: If they have it, I want it too.
If we don’t join in, we feel like we’re being left behind. And this is the same psychological sensation that fuels lifestyle inflation—the need to upgrade our spending as those around us do.
The only difference is that, in investing, FOMO doesn’t just lead to overspending—it can lead to large losses.
When a stock starts gaining momentum, more people want to join the herd and pile in, pushing the share price higher and attracting even more buyers.
This cycle perpetuates until the stock eventually reaches a point where the valuation is too far gone from reality. And reality always comes home to roost, so the bubble must inevitably pop.
That’s why Green warns that buying high-flying stocks at extreme valuations is often a losing bet. The higher the share price climbs, the more fragile the investment becomes (and the more risky it is to put money in it).
Looking at a real-life example of this in action, right now, Palantir (PLTR) is one of the market’s most beloved stocks.
With a cult-like following, a story built around AI dominance, and a share price that has skyrocketed, it’s the textbook definition of a high-flying stock that investors will pile into despite its steep valuation.
To be clear, Palantir is not a bad company. The problem with it is that people are buying it in droves even though it currently trades at a P/E ratio of 200 and a price-to-sales (P/S) ratio of 66.7—essentially, nosebleed valuations that assume near-perfect execution and massive future growth for a long time.
For context, even the hottest growth stocks typically don’t trade at such crazy valuations. NVIDIA (NVDA), which has been the poster child of the AI boom, trades at a forward P/S ratio of around 25—still pretty high, but way lower than Palantir’s 66.7.
The only way such valuations hold up is if Palantir’s revenue and earnings continue to grow at an exceptionally high rate for years to come. If that growth slows even just a little bit, the stock could come tumbling down as investors start to think that the party might be ending.
Looking to the past, history offers many examples of companies that were once like the Palantirs of today, one of which was Zoom (ZM).
In 2020, when the pandemic made video conferencing essential, Zoom was the golden child that everyone wanted a piece of. At its peak, Zoom traded at over 100 times sales, but as things got back to normal and growth slowed, the stock collapsed from $560 per share to under $70 (it’s sitting at about $86 as I’m writing this).
The moral of the story is this: even great companies can be poor investments if you buy them at the wrong price. Never forget Ben Graham’s three magic words: Margin of Safety.
Also, if you can, resist the urge to blindly follow the crowd. And before jumping into a stock just because everyone else is, ask yourself: Am I investing based on fundamentals, or am I just feeling FOMO and following the herd?
With that said, I want to hear from you: Have you ever invested in a stock at its peak and regretted it? Or, have you ever resisted the hype and been glad you did? Write to me here and let me know.
And if you want to learn about a few stocks that might be on the verge of cutting their dividends, check out this video here.
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ICYMI 🎥
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CAREFULLY CURATED 🔍
📺 Breaking The 4% Rule - The 4% rule has long been considered the go-to strategy for withdrawing from your investments in retirement, but how does it compare to just relying on dividend income? In this video, my friend JP Dividends takes a deep dive into the topic and breaks it all down.
🎧 Gamifying Investing - This episode of the Business Breakdowns podcast (which is one of my favorites) is the first in a multi-part series on the video game console market. I learned a lot from this episode, and I think you will too.
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SINCE YOU ASKED 💬
"If the stock price goes up, does the dividend go up as well? And vice versa? I'm a bit confused about why dividends change."
- @RRedmondiy43 | YouTube
This is a fantastic question. I often talk about how—no matter what the share price is doing—the dividend per share doesn’t change. At the same time, I also point out that when a stock's share price goes down, its dividend yield goes up.
While both statements are true, I understand how that can seem a bit contradictory, so let’s break it down to make it make sense.
The best way to explain this is by looking at how the dividend yield is calculated. It is simply a stock’s annual dividend per share divided by its current share price.
As an example, let’s say a stock pays $3 per share in annual dividends and trades at $60 per share. In this case, the dividend yield would be 5% (since 3 ÷ 60 = 0.05, or 5%).
Now, as we all know, share prices fluctuate every day. Suppose that tomorrow, the stock rises by 1.5% (maybe they reported strong earnings or something), bringing the price up to $60.90.
Even though the share price has increased, the dividend per share still stays at $3. However, when we recalculate the dividend yield, we get 4.92% (3 ÷ 60.90 = 0.0492).
When the share price goes up, the return you would receive in the form of dividends—if you were to buy at the new, higher price—goes down.
On the other hand, if the share price were to fall to $55 per share, the new dividend yield would increase to 5.45% (3 ÷ 55 = 0.0545). This makes sense because the dividend per share is now higher relative to the reduced share price.
To sum it all up: The dividend per share (the $3 in our example) does not change based on the share price. What does change is the dividend yield.
When the share price goes up, the dividend yield goes down. When the share price goes down, the dividend yield goes up.
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LAST WORD 👋
Over the past couple of weeks, I’ve been diving deeper into poker.
I always had a general understanding of how to play—maybe around 80%—but I never fully grasped the exact ranking of hands. Once I nailed that down, I started playing a lot of free poker on the WSOP app. Now, I want to keep improving and take my game to the next level.
For those of you who are into poker, do you have any book recommendations, websites, or other resources that could help me develop my skills? I’d love to keep learning and refining my strategy.
Thanks!
