How To Figure Out What's Hot And What's Hype

Movie companies have long been prone to hyperbole, but even by Tinseltown standards, First National Film Corp. really outdid itself. In April, a month before the release of Happily Ever After, promoted as a sequel to Walt Disney Co.'s Snow White and the Seven Dwarfs, a spokesman told the news media that it would gross $30 million to $50 million. Anticipating a hit, investors sent the stock soaring from 4 1/2 in March to more than 9 1/2.

But Happily Ever After bombed. The film got poor reviews and has taken in little more than $3 million. First National refuses to answer questions about the movie or the projections. Meanwhile, investors who bought into its promotions are holding the bag: The stock now trades at less than 2.

First National's rise and fall is no isolated case. Hype is running rampant on Wall Street these days as small-company stocks boom and investors hunger to latch on to the next Microsoft Corp. or Home Depot Inc. "This is one of those times in the market that is filled with bubbles and manias," says David W. Tice, a Dallas CPA and analyst whose Behind the Numbers reports often attempt to burst those bubbles.

Of course, the stock market's main game is making judgments about the earnings potential of public companies. And judgments are subjective: One person's hope is another's hype.

Hype may come from the company, as it did from First National Film. But securities firms and their analysts have been known to whip up a frenzy about a company with armies of dialing-for-dollars stockbrokers. Stock promoters may make statements about a company that are wrong, but regulators at the Securities & Exchange Commission say companies aren't under any obligation to correct them. In the end, the best way for investors to protect themselves from hype is to know the signs:

-- The great idea. Much of the hot air right now is in casino stocks. Casino Magic Corp., which runs Mississippi riverboat casinos, announced on June 9 a proposal for a riverboat casino up in Buffalo. Sounds like a moneymaker, except for one thing: Riverboat gambling isn't legal in New York State. The company knows that, of course, but says it has had discussions with state leaders in hopes of changing the law. The stock gained by 18% in the week after the announcement. "When you're investing in an idea rather than a real product or real service, you can get in trouble," warns Roger B. McNamee, general partner of Integral Capital Partners.

-- The hot stock group. While changing corporate strategy isn't uncommon, the fact that a company chooses a "hot" industry should raise red flags. "Why should investors think a management will succeed in an industry they know nothing about?" asks Robert S. Natale, editor of the newsletter Standard & Poor's Emerging & Special Situations.

Just look at Skylink America Inc., a tiny cable TV company with less than $5 million in revenues. On June 14, Skylink said it would enter the gaming business by combining operations with a privately held company that had an application for a riverboat casino in St. Charles Parish, La. The stock, which hadn't traded above 2 since 1987, ran up from less than 1 to more than 5 in the next four days. On June 18, the Louisiana application was granted, and stock is now at 7. The company plans to use a casino management firm to run the gambling unit.

-- The company promotion. First Pacific Networks Inc. in Sunnyvale, Calif., is developing devices that combine video, telephone, and data signals on one wire. First Pacific has also developed a reputation--which company officials insist is wrong--as a self-promoter after two incidents earlier this year. In one, a staffer told a wire-service reporter that a joint venture with Southern Co., a major electric utility, could generate annual revenues of $1 billion. The stock shot up more than five points, to 26 1/2. The next day, the company disavowed the projection, and the stock gave back the gain.

But that's not all. Around the same time, CNBC canceled an infomercial, featuring First Pacific and two others, that was organized by Josephthal, Lyon & Ross Inc. and produced by an independent production company. "The program bordered on touting," says Brian Lewis, a CNBC vice-president. For instance, he says, "the stock symbol was in the upper right hand corner of the screen the whole time."

The stock, though down from its peaks, still trades at 17 3/4--which gives a market value of $319 million to a company with less than $3 million in sales. Chief Financial Officer Ken Schneider admits that's a high valuation, but likens FPN to a biotech company in which today's investors are paying for tomorrow's revenue and earnings. But Tice, the Behind the Numbers man, thinks the stock is still overpriced.

-- The aggressive analyst. Sometimes, shares soar when they're recommended by a well-known research analyst. That's what happened when Immune Response Corp. doubled in the weeks leading up to the Ninth International Conference on AIDS in early June, where the biotech company presented its research on a therapeutic vaccine. The stock collapsed when the report disappointed investors, and now, Immune Response trades at 12 1/2, down from 27 1/4 on June 1.

Investors familiar with the company say San Francisco analysts R. Brandon Fradd of Montgomery Securities and Mark J. Simon of Robertson, Stephens & Co. were aggressively recommending the stock while the company stayed mum in the weeks leading up to the conference. Fradd says Immune Response's test results didn't disappoint him, and they don't preclude an accelerated approval from the Food & Drug Administration for AIDS therapy. "If saying there's a possibility of a cure for AIDS is hype, then I'm guilty," says Fradd. "But it's a free market, and everybody can vote with their money."

Analyst Simon says he recommended Immune Response at 15 on May 14 for investors who could stomach the risk. He figured the stock could double if the research came in as he expected--or drop five to seven points if it were a complete failure. He thinks the company's AIDS research is good, "but by the time the stock hit 25, investors were already expecting a cure."

Although many companies and investors consider short-sellers the dregs of Wall Street, they in fact perform a service. Short-sellers hunt down hyped stocks and try to deflate them. They borrow shares of target companies, sell them, and plan to replace them when the stock price falls. A large short interest, which is reported monthly, may signal that a company's stock has been hyped.

But with many small companies, selling short isn't easy. Large blocks of these stocks are often in the hands of company insiders, who don't make them available for shorts to borrow. And if a short can borrow shares, the owner can call them back anytime, forcing the short to bid up the stock price in order to replace them. That's what's known as a "short squeeze."

Of course, nothing deflates hype like old-fashioned homework. Investors burned in First National Film might have been spared if they had done a little research on Hollywood: Only one in three films even breaks $10 million, and kiddie films really have a hard time because much of the take is in half-price children's tickets. The moral: Those who see through hype live happily ever after.

Before it's here, it's on the Bloomberg Terminal. LEARN MORE