It's pretty much one of the worst feelings in the world for an investor. Jim has done his research, narrowed down the field of potential "buys," and finally picked the stock that he likes.
Unfortunately, while Jim was busy debating, the stock shot up from $50 to $100 per share. Frustrated, Jim decided to look elsewhere to invest his money, convinced that he "missed the boat."
As I've said with many of the investing biases I've been investigating, the reasoning here is easy to understand, but this line of thinking can be very dangerous to Jim's portfolio.
The name for what we're covering today is anchoring. Read on to see what anchoring is, why it can hurt investors, and what you can do to mitigate the consequences of this bias.
Anchoring in the real world
In the most simplistic terms, anchoring refers to the fact that the values of many things in life are relatively arbitrary. As humans -- and especially as Western thinkers -- we don't like this kind of uncertainty. So we develop a tendency to rely far too heavily on the first value, the "anchor," that is given to something.
Imagine if I ask one group of people: How tall is the world's tallest building? Do you think it's over 10,000 feet?
Then I ask a second group: How tall is the world's tallest building? Do you think it's over 5,000 feet?
When similar questions have been asked to participants in studies, those in the first group guessed a height significantly higher than those in the second group. The only difference was that each group was given a different anchor.
Anchoring in the investment world
The same thing can happen on the stock market, as it did with our unfortunate investor Jim.
When a company is firing on all cylinders, the price of its stock is likely to go up. We anchor to the original price we saw the first time and assume that there's no room for growth left once the stock appreciates in value.
Imagine if you didn't buy Amazon.com at a split-adjusted $10 because it had been $3.50 just three months earlier, as was the case in late 1998. Sure, you missed some gains, but you'd still be sitting on a 27,300% return right now. Missing out on returns like that is why the anchoring effect is so dangerous.
Here are three stocks that have appreciated a great deal since Labor Day. But if you assume they're not worth your money now, I think you'll be committing the sin of anchoring to past prices.
Price Change Since Labor Day
Creates water solutions for
Designs and manufactures
Source: Google Finance.
Serial entrepreneur Richard Heckmann leads Heckmann, by far the smallest of the three businesses. The company aims to capitalize on the recent energy boom in the United States. One of the reasons for the boom is the advent of new fracking techniques -- which require both lots of water and the subsequent treatment of that water.
By acquiring Power Fuels, Heckmann added further credence to its commitment to help clean the water used in the fracking process. And not to be ignored, the company has increased revenue by a whopping 155% over the past year and is expected to have its revenue increase threefold by 2014.
3D Systems, on the other hand, is one-half of the 3-D revolution that many believe is just beginning. Though the company trades for a sky-high P/E of over 100, there are several reasons to believe that in the coming decade, the company's market cap could be worth far more than today's $4 billion.
For starters, 3-D printing alone holds untold possibilities. But beyond just potential, the company has increased revenue by 44% over the past year, and earnings by 81%! There really is no telling where this company could be in 10 years.
Finally, we have Intuitive Surgical. Even though it's up only 18% since Labor Day, I included it because it's increased 21% since late December alone and had an 11% pop just this past week.
Though the company now trades for about 36 times earnings, it might look too expensive. But there's no telling how many procedures the company's daVinci Robot will be able to perform in the coming years.
To help investors decide whether the future of additive manufacturing is bright enough to justify the lofty price tag on 3D Systems' shares, The Motley Fool has compiled a premium research report on whether 3D Systems is a buy right now. In our report, we take a close look at 3D Systems' opportunities, risks, and critical factors for growth. You'll also find reasons to buy or sell, and receive a full year of analyst updates with the report. To start reading, simply click here now for instant access.
The article Anchor to the Price of These 3 Stocks, and You Could Miss Out originally appeared on Fool.com.
Fool contributor Brian Stoffel owns shares of Amazon.com, Intuitive Surgical, and Heckmann. The Motley Fool recommends 3D Systems, Amazon.com, and Intuitive Surgical; owns shares of 3D Systems, Amazon.com, Heckmann, and Intuitive Surgical; and has options on 3D Systems and Heckmann. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
Copyright © 1995 - 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.