Don't Water the Weeds

 | Feb 25, 2014 | 4:00 PM EST  | Comments
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Stock quotes in this article:

znga

,

kin

Earlier this year, a 5% correction in the S&P 500 turned out to be nothing more than a hiccup. The market has come roaring back and is flirting with a new record, again. The thirst for equities at any cost is back and that is a signal for investors to take heed. The seeds are being planted and it's critical to understand what is growing.

Consider that so far in 2014, the best performing stocks have been unprofitable companies. When you start seeing money being poured into companies that are producing no earnings, you can make one very reasonable conclusion: Greed and fear of missing out on gains is starting to affect investor behavior.

Biotech stocks -- many of which of never create a viable product and often go bust -- have been surging in 2014. The Nasdaq Biotechnology Index has moved up 25% in 10 weeks. Of the 122 companies that make up that index, less than 30% of them made any money in past year. Thanks to the hype surrounding the legalization of marijuana in certain states, penny stocks that purport to support the legalization of pot have surged.

Systemically unprofitable companies are also moving higher. For example, Zynga (ZNGA) is up over 50% this year for no other reason, it appears, than because folks are looking to chase a rising stock price. Consider, for a minute, if you were offered a chance to buy a $4 billion parcel of commercial real estate that looked very attractive on the outside and was near full occupancy, but, because of the mortgage payments, was bleeding money? Would you buy it? I doubt it. But if you buy shares of Zynga, that is exactly what you are doing: paying $4 billion for a company that generates $870 million in annual revenues and lost $37 million in past year.

Against this backdrop, financial advisors are allocating record sums of client capital into equities. Tragically, it's understandable why this is so. These stewards of capital do not want to be left behind and watch assets move from themselves to the next advisor who is making "enviable" returns, thanks to a rising market.

It's very difficult to watch the market climb higher and have someone like me attempt to preach that there is nothing attractive to buy. If you look closely, there are stocks worth considering and for investors to follow and watch. Last month, I noted that Seth Klarman had taken a huge stake in small-cap animal biotech company Kindred Biosciences (KIN). The shares are up nearly 70% since then and in this case, KIN is truly a biotech with a bright future.

But opportunities for intelligent capital allocation are getting slim. So if you are speculating -- and know you are speculating -- then I hope you have the discipline to understand that what you are doing carries a high degree of loss. But if you think that investing in anything and watching it go up makes you an investor, you will soon find out who the fish at the poker table is.

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