A few months ago, ‘Stonks’, which is an internet slang for popular stocks made popular by social media, became all the craze.
Also, since the GameStop and AMC saga, the social media trading community heavily promoted this community spirit concept called ‘Diamond Hands 💎🙌’, which urges all traders and investors to hang on to their stonks regardless of the risks and losses just to get to an end goal. It is often used to call on a group’s collective strength to get through high water or hell.
In fact, the extent and influence of Diamond Hands 💎🙌 apply to all things speculative and trendy, and Electric Vehicle plays definitely fall in that category.
In this article, we plan to share how Diamond Hands 💎🙌 have caused one of our community members to lose money without realising he is likely to lose more. Furthermore, we also plan to educate our community on how to avoid encountering such loss-making opportunities in the future.
What happened to our Community Member?
On 22nd December 2020, one of our community members bought into QuantumScape (QS) at $102 on the day low, after being encouraged by several of his friends that had read from social media the highly rewarding opportunity presented by the ‘Stonk’.
Between 27 November 2020 to 22nd December 2020, QS had gained a monstrous 436%. In part, these are several reasons why QS benefited from such gains:
- Joe Biden was elected President with promises of fulfilling clean energy and electric vehicles
- Elon Musk as an avid tweeter managed to garner a huge follower base on social media
- QuantumScape had promising technology as a EV battery developer
- The combination of these few factors invited a huge flow of capital into QS
When we asked this community member why he bought into QS and his response was that in hindsight he really shouldn’t have – he bought it on pure greed thinking it was just going to go up further. In fact they were 2 trading days where his position was still profitable. Following 29th December 2020, QS began its spiral downwards. As of 13th April 2021, QS traded at $48.84 which represented a -68.45% loss.
When we asked him what he was going to do, he replied he didn’t know and will probably just hang onto his shares and hoping it will break-even one day, making reference to Diamond Hands 💎🙌.
What’s the problem with Diamond Hands?
The first problem with QS is that it is currently not making any revenue, and is not expected to make any revenue for the next 5 years.
Key Learning #1: Regardless of how promising a technology or prospect may be, be careful when trading stocks that do not generate any revenue.
Let’s all think about this deeper, if a company is not expecting to make any money for a few years, how can it survive? This is irrespective of how promising the technology and prospects may be. R&D costs need to be incurred, and wages still need to be paid.
Now there are two ways that low to no revenue companies can acquire more cash to survive:
- Issue debts (this is unlikely for risky no-revenue companies)
- Raise cash through additional share offerings or investments
Option 2 is precisely what QS planned to do, and had in fact done before. On 22nd March 2020, QS announced that they will raise more cash through a public share offering. In fact, the last time QS did this on the last day of 2020 (new year’s gift to investors), QS dropped a dismal -40% from $84 to $50 by raising $100M through stock offering!
Key Learning #2: When a No/Low Revenue Company raises cash through share offerings, this will cause further share dilution, hence lower share prices.
It is all about demand and supply. When Share supply increases, Share prices will inadvertently drop.
Share Dilution is every investor’s worst enemy
The chart below is another example of how a very promising company (Amyris) with amazing technology had eroded shareholders’ value since 2011 by raising rounds and rounds of cash to survive and develop their technology.
Just to give our community readers an idea of how dangerous share dilution can be, Amyris started with a $86M share offering in 2010, and increased it to $407.75M by 2020. This represents a 374% share supply increase. Correspondingly, between 2010 and end 2020, Amyris share price dropped -98% in this 10 year period!
Key Learning #3: By being an early investor in promising prospects, be prepared for many years of negative returns with the possibility of share prices staying depressed for a very long time.
Buying high, holding onto losses, and hoping stocks will break even eventually is a bad investment strategy.
Conclusion
We are living in a digital trading world now, where trades are done electronically and are driven by algorithms and different types of data such as Tweets and social media influences.
However, the underlying drivers of equity prices are still determined by market greed and fear with humanistic characteristics.
Key Learning #4:
As compelling as social media influence can be, such as the unity of traders via ‘Diamond Hands 💎🙌’ or even FOMO (Fear of Missing Out), our community readers must understand the ill consequences of such influences.
In this article, we’ve pointed out to our community readers several traps associated with no/low revenue companies that are speculative plays, and why a ‘Hang on for Dear Life’ (HODL) approach can be very dangerous.
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