Twitter, Internet Stocks and Extraordinary Popular Delusions

Investors' crazy behavior towards Twitter is a danger sign

[BigTrends.com Editor's note: We would point out that Facebook (FB) is probably the most similar recent major IPO to Twitter. And in fact FB shares are now well above the IPO price, despite many decrying this as an overpriced, overhyped IPO at the time of issue.]

Investors' recent behavior bears a scary resemblance to what happened in the late 1990s, before the Internet bubble burst. The latest example is a penny stock that soared 1,800% after being confused with Twitter.

All a company has to do to make money in the current market environment is to change its name to something that sounds like Twitter, or have a similar ticker.

You think I'm kidding?

Consider what happened last Friday to the stock of Tweeter Home Entertainment , which up until then had been hovering at the lofty price of less than a penny per share. Even though the company is in bankruptcy, its ticker - until it was changed earlier this week - was TWTRQ. Twitter, of course, has proposed that its ticker be TWTR .

Evidently, because the company's name and tickers are similar enough to Twitter's, eager investors snatched up the stock, causing it to soar 1,800% . Never mind that Twitter has yet to go public.

If this sounds like irrational exuberance, it's because it is.

We should all be remembering the parallels to a scarily-similar lunacy that was widespread at the top of the Internet bubble.

One of my favorite examples comes from an academic study in the prestigious Journal of Finance about companies in the late 1990s that added ".com" to their names. It involves AppNet Systems, which in March 1999 filed papers for an upcoming IPO with a proposed ticker of APPN. Unfortunately, there was already another company with that ticker: Appian Technology, an inactive circuit manufacturer whose shares traded on the OTC Bulletin Board for less than a penny each.

This didn't stop Internet-hungry traders from snatching up Appian's shares, however, causing the stock to soar 142,757% in the two days after the filing.

Spectacular as this was, however, it was not unique. The researchers focused on 95 separate instances in the late 1990s in which companies added ".com" to their names, and found that, their stocks' average short-term reaction was to jump 74% more than comparable stocks .

The professors argued that this behavior bore a "striking resemblance" to the investment manias catalogued in Charles Mackay's famous book "Extraordinary Popular Delusions and the Madness of Crowds." As they wrote:

"The common feature in all these manias appears to be that the industries are new 'glamour' industries with both an enormous growth potential and uncertainty. Consequently, investors appear to be extremely anxious to buy shares of any firms that are involved in these industries. Investors may even be frantic to buy shares in firms that are at best, only loosely, if at all, connected to the current glamour industry."

To be clear, let's add that it's no criticism of Twitter itself to point out that investors are reacting irrationally to the company's name and ticker. We don't yet even know sufficient details of Twitter's upcoming IPO to make an informed judgment about its valuation.

I will say, though, that companies typically sell stock to the public when valuations are favorable. That's why IPO activity in 2008 and 2009 nearly dried up. So it would be irrational for Twitter not to rush to market as fast as it can, in order to exploit investor irrationality by raising as much money as it can.

But that doesn't mean it's a good idea for you to participate in their attempts to raise that money.

Courtesy of Mark Hulbert, marketwatch.com