What are the risks of buying stocks featured in news articles?

Question

I noticed that a fellow family member (let's call her Alice) has an unusual stock selection method. This is the research process:

• Form an opinion of specific industries,
• Read news articles online (mostly on Yahoo Finance) that mention or feature some companies in those industries,
• Select a few of the "promising companies" that were mentioned in articles (usually large-cap blue-chips),
• Look up their "profit" on Yahoo Finance (this typically takes less than a minute),
• After a few days, decide to buy one or two of the selected stocks.

I initially had some objections to this "research process" when I first heard of it a few years ago. Buying large-cap stocks made the method seem safer, but I also thought that the process relied too much on personal feelings. I wanted to respect Alice's freedom to decide on her own investments, so I left my objections aside.

Recently however, Alice became excited about biotech stocks that were featured in some news articles. Some of these are biotech penny stocks. This made me worried, because I associate biotech penny stocks with high volatility and high risk of loss. I want to know if my concerns are justified. Can the news-based research process I outlined above be considered intelligent, or is it just ignorant speculation? What are the risks of buying stocks featured in news articles?

Answer 1

Lets assume that the news articles are real news in real news sources, and the stocks are blue chip. The risk is that by the time you read the news item, millions of others have also read the news. The price movement due to the news item has already started, and may have already been missed. Any future movements are due to readers of articles not due to the fundamental event mentioned in the article.

In the above scenario, if the goal was to only own for a small period of time it is likely to miss the gains. But if they own the stock for years, then missing the initial gain may not be a problem.

The issue with the less known stocks, and penny stocks, is that the news article maybe isn't news. It is an advertisement written to look like news. The goal of the advertisement is to get people to buy the shares. They want you to buy because they want to sell their shares to you. The risk is that there is no market for these shares because the information in the advertisement was either a lie or an exaggeration. Once enough people buy the shares, the market disappears.