Herd Mentality


Herd mentality is a major reason for the stock market’s periods of euphoria and panic. For instance, herd mentality ran rampant during the technology boom. Common investor sentiment was that the technology industry was the future. It was a revolution! With herd mentality as it is, common investors invested in technology stocks with fervour, else be left out of the greatest perceived money making opportunity in history. Indeed, the crucial motivating factor underlying herd mentality is simply that people do not want to be left out of the group. In effect, those common investors ignored underlying business value and subsequently bid up technology businesses with negative earnings, claiming “this time, it’s different”, that P/E ratios do not apply because “the technology sector has infinite earnings growth”. Further, the successful investor understands herd mentality and avoids it. He is like the lone wolf. If common investor sentiment is rosy, the successful investor becomes weary. If the successful investor hears that his barber, who has never invested in the market, now is, he becomes scared. When sheep are being round up, the successful investor heads the other way, because sheep get slaughtered.



Case Study: It’s Fun Until Everyone Gets Hurt
An interesting story is of that regarding Nortel. On a plane trip from Toronto to Vancouver in 2002, the successful investor overheard an Air Canada flight attendant complaining to fliers of his dreadful Nortel stock investment, which during the technology boom was the preeminent market darling. Interestingly, almost half the fliers on the plane reacted to his complaint as if they had all too lost significant money in Nortel’s stock. If one were to have asked those fliers what Nortel’s business model was, however, they would have likely been dumbfounded, answering, “everyone else was investing; they were making money, so we didn’t want to miss out”. The herd mentality also occurs in times of gloom. When the herd is touting the stock market is dead, the successful investor is having a party and buying pieces of quality businesses at dead prices.

Lesson Learned 54: If you believe what the herd is thinking, you are not thinking.