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Definition:  Hot stocks are high demand stocks that investors are excited to invest in. Usually, this type of demand for a stock takes place either in anticipation of an initial public offering (IPO) or because the stock consistently outperforms the market due to strong financial results.

What Does Hot Stock Mean?

What is the definition of hot stocks?  When a firm’s  shares  are offered to investors through an IPO, the hype is strong. The anticipation is high and investors jump on the bandwagon, causing the  demand  for a particular stock to outpace  supply . Therefore, the stock price usually rises a lot in the short term. However, in the long term, the stock price may decline. The hype ceases, but traders are trying to sell the stock at a higher price than the firm’s fair value, thus pushing the share price down.

Most of the IPO stocks are overvalued, but the initial investors can gain significant returns by investing in stocks before they are listed. Furthermore, the hype around an IPO triggers traders to the sector that the firm operates, thus pushing up the stock prices of similar companies. Besides an IPO, a stock can be in high demand because of the  dividends  it distributes or because of strong quarterly results that boost investor confidence.

Let’s look at an example.

Example

A perfect example of hype around an IPO that caused the stock price to skyrocket is the IPO of Facebook on May 18, 2012. Before the listing, the target price of Facebook increased, aiming for a valuation between $28 and $35 per share or a  market cap between $77 billion and $96 billion.

A few days later, the target price rose to a valuation between $34 and $38 per share. The strong demand for the stock, mainly from retail investors, convinced the underwriters that a target price of $38 and a valuation of $104 billion was completely justified. The first day of trading, the stock closed at $38.23, whereas the following 15 days, the price declined by 37.91% to $27.72 on June 1.

There are always hot stocks and hot peaks for all sorts of investors. However, it is better to look at a stock’s fundamentals and growth prospect rather than investor hype. A firm with strong financial results is more likely to distribute an annualized dividend, thus creating a steady stream of income for shareholders.

Summary Definition

Define Hot Stocks:  A hot stock is a company share that investors drive up demand for because of company performance or simply market hype.


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