Institutional investors are supposed to be the smart money. These are the guys and gals who went to the best schools and got the best grades and are now paid the big bucks.
They oversee trillions of dollars of investors’ capital and can move markets by going on TV and talking about which stocks they like.
The financial media treat them like rock stars and individual investors slavishly follow them. I bet I see 20 headlines a day that reference the smart money and what they are buying and why you should follow them.
The important thing to remember about these smart-money investors is the biggest risk they all face each day. It is not market risk, interest rate risk or credit risk.
It is career risk. As John Maynard Keynes once pointed out, “Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally.”
The first thing they worry about each day is not getting fired. Getting paid six figures is a pretty good deal these days, so it makes sense do pretty much what all your peers are doing. Odds are, for right or wrong, you won’t get fired for buying what everyone else is buying. It is one of the biggest reasons that many managed funds look a lot like index funds.
The problem with the career protection group is that you end up with a very high concentration of institutional ownership in many of the more popular stocks. Those stocks with high expectations get bid up to unreasonable valuation levels by all this career protection buying.
When expectations or results begin to waver as they eventually do, it is going to be a very crowded exit. Individual investors who are not in front of a screen all day will come home to find these overloved super-stocks down 30%, 40% and even 50% as all that money tried to get out the door at the same time.
Veeva Systems Inc (NYSE:VEEV) is a great example of such a stock. This company does all sort of cool stuff in the medical field. They provide cloud-based software solutions for the life sciences industry. Their software helps manage client relationships and the sales process as well and running the business itself.
They also help the process of managing records and compliance. Cloud computing and healthcare are two hot fields in today’s market and the stock has attracted a lot of attention.
In fact, institutions own about 83% of the stock right now and all that buying has pushed the stock up to 93 times earnings. If they were to fall even the tiniest bit short of the optimistic analyst expectations or a competitor begins to take market share from them, the exit door is going to get crowded fast.
If the folks at T.Rowe Price sour on the stock and decide to sell their 7.7 million shares, it would take the market about a week to buy up all that volume and the stock would take a beating.
I pick on Yelp Inc. (NYSE:YELP) all the time and I have been rewarded as the shares have fallen by about 10% this year. My wife loves it and uses it constantly, as does my daughter, but that doesn’t mean this a great stock by any means.
However the smart money loves it and institutions own 81% of the company. If Yelp continues to fall short of expectations, and I suspect it will, who is going to buy the 60 million or so shares that institutions own? It is reasonable to assume that the multiple will shrink considerably from the current 165 times trailing earnings and 93 times the expectations for the next year.
The thundering herd of Wall Street is a very real thing. The smart money head to work each morning and their biggest goal is the same as everyone else on the planet — to not lose the very good jobs they have. As a result they tend to buy the same stocks at pretty much the same times as their peers and competitors, and sell when everyone does.
If you get in before they do their buying, you can make a lot of money. If you own a stock they decide to sell, however, they will trample you with their desire to sell before their bosses can notice they still own it.
As of this writing, Tim Melvin did not hold a position in any of the aforementioned securities.
