On Investment Contests

I received a question from a friend of mine and want to give an answer:

Background: I teach high school physics.  In my AP class, I have some cross-registration with the Micro-econ & Personal Finance classes.  In those classes, they play the “Stock Market Game” in which they’re given $25k and compete for the semester for the highest total.  Inevitably, discussion of economics, stocks, and that game finds its way into my class where I am incapable of _not_ getting involved.

Problem 1: The game only lasts for a semester (4 months).  Result: very short term thinking

Problem 2: The teacher pushes stock-chart reading, “200 day average vs 50 day average”, looking at price movements, etc.  There is little (if any) balance sheet reading, company growth investigation, or stock price evaluation going on.

Relevance for here: The kids immediately turn to penny stocks thinking to make a quick buck- “If I buy 50,000 shares of this company at $0.25, I can sell it for a huge profit when it goes up to $0.50.

Question: Do you have any recommendations for short quips / talking points to reveal their folly to them? 

(I had a kid last year almost not graduate when he became so enamored with playing the stock market that he thought he could “crack the code” and make a fortune off penny stocks.)

I have only experienced one good investment contest in my life.  It was in 1983-1984, when Value Line sponsored a contest offering significant prizes.  They did something unique: they divided the market into 10 groups sorted on volatility, and told investors that they had to pick one stock out of each of the ten groups.

Brilliant. this eliminated the ability of people to just pick risky stocks, and bet on getting lucky turning the whole thing into chance.

A portfolio of ten equally-weighted stocks demonstrates more ability than a single pick.  For any single stock, or concentrated portfolio that does well, the answer should be that they got lucky, as humans see it.

As it was, in the Value Line Contest, I finished just short of getting a prize.  My returns were less than a percent behind the lowest winner.

Now as to what you should do, dear friend, in the short run, momentum matters more than valuation, most of the time.  The teacher may be giving them the right advice for the contest.  Personally, I would go to the teacher, rather than the students, and tell him to do a contest more like Value Line did.  If he needs help with the volatility groups, I can provide the data.

But the two main things to point out on penny stocks is this: 1) Most people investing in penny stocks lose a lot of money, because the stocks seem cheap, but they have little in assets or earnings relative to their price.  2) There are penny stock promoters who tout penny stocks so that others will buy at a higher price, so they can sell to them, and the new buyer can experience the losses.

If the contest is structured properly, it should have a minimum capitalization limit, and a diversification requirement.  Tell the other teachers to consider this.