Banking

Why that hot stock in your portfolio might be no better than a lottery ticket

Like Claude Rains’ character in the classic film “Casablanca,” would you be shocked to discover that a lot of gambling goes on in the stock market?

Prepare to be shocked. According to just-completed research, gambling in the stock market is far more prevalent than previously imagined. The study’s authors — all finance academics — calculate that the dollar value of the gambling is at least three-and-one-half times the combined global total of activities at casinos, online gambling, gaming machines, bingo/keno, lotteries, horse tracks and sports betting.

So don’t judge those who frequent casinos, lotteries, horse tracks, and the like. Your activities in the stock market aren’t necessarily different, even if “investing” carries with it more societal legitimacy than “gambling.”

The study, entitled “Only Gamble in Town,” was conducted by Alok Kumar of the University of Miami, Huong Nguyen of the University of Da Nang in Vietnam, and Talis Putnins of the University of Technology in Sydney, Australia.

Since the distinction between gambling and investing is a function of investor intent, it’s impossible to directly measure how much gambling goes on in the stock market. The researchers get around this difficulty by focusing on the trading volume of a group of so-called lottery stocks that are most likely to interest gamblers. If no gambling were going on in the stock market, then the trading volume of these stocks (relative to past norms) would be no different, on average, than for non-lottery-type stocks.

That’s not what the researchers found. The researchers define these lottery stocks as those that have low prices, high volatility, and return distributions that are positively skewed. This last characteristic means that they have a small probability of a really big payoff. Examples of lottery-price stocks that Kumar mentioned in an interview include:

•       Agenus
AGEN,
+0.81%
 

•       Amarin Corp
AMRN,
+4.90%
 

•       Astrotech
ASTC,
-17.28%
 

•       BioCryst Pharmaceuticals
BCRX,
+2.75%
 

•       Iamgold
IAG,
+1.12%
 

•       Immunogen
IMGN,
+4.62%
 

•      Mesa Air Group
MESA,

 

•      Socket Mobile
SCKT,
-6.49%
 

•      Spectrum Pharmaceuticals
SPPI,
+3.55%
 

•      Urban One
UONE,
-0.80%
 

Though these stocks are hardly household names, Kumar said that’s to be expected. Usually by the time a stock has become a household name it will have a much higher price and significantly lower volatility than the typical lottery stock. An example is Netflix
NFLX,
+3.69%
 , which in its early days as a public company did satisfy the researchers’ definition of a lottery stock. It does not today.

Note carefully that someone could own a lottery-type stock for reasons having nothing to do with gambling, just as it’s possible someone could be gambling with a non-lottery stock. But, assuming these two possibilities cancel each other out, the difference in the relative trading volumes of these two groups of stocks should be a good estimate of how much gambling occurs in the stock market.

Confirmation that the researchers are in fact measuring gambling activity in the stock market came when countries imposed restrictions on traditional gambling activities. In the wake of those restrictions, trading activity in lottery stocks jumped. Likewise, when those restrictions were relaxed, trading activity in lottery stocks often fell.

Investment implications

While this study’s findings have major cultural, social and psychological significance, I’m interested in its investment implications. Perhaps the most crucial is that lottery stocks may be overvalued. That’s because these stocks’ prices will have been bid up beyond where they would be trading if no gambling were to take place.

That doesn’t mean that no lottery stocks will richly reward those who purchase them. Some will, just as someone will win the state lottery. But that’s different than saying that these stocks, on average, are good long-term investments.

You might think that regulators should try to discourage gambling in the stock market. But the researchers distance themselves from this suggestion: They find that “stock market gambling increases the amount of information that is reflected in prices, increases measures of informational efficiency, and reduces measures of noise in prices… Therefore, even if gamblers are relatively or completely uninformed traders, they can still contribute to market efficiency by making markets more liquid and thereby encouraging informed trading.”

While the macro effects of gambling may be positive, that doesn’t mean you should engage in the activity yourself.

Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at [email protected]

More: The asset class you probably haven’t even considered

Plus: Most investors now expect the U.S. stock market to crash like it did in October 1987 — why that’s good news

 

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