Why would investing in rising stock not give profit?

[For a brief answer, skip to the bottom]

@F1Krazy gave a great explanation of how early investment in rising stocks before they start rising makes the client a higher profit. Investing in a stock early on, before it starts rising, means that you can buy the stock at a much lower price than once it starts rising. Therefore, making a higher profit when you sell. Between purchase and sale, it’s all fugazi (paper profits, only).

Most people do not have the forethought, ability, insider knowledge, or luck to do that. Most people buy stock based on the stocks history. But, past performance does not indicate future results. Most people will just buy a stock that has already proven itself to be a rising star, when it may be at its peak of price, expecting it to rise more.

They rely on consumer publications like the Wall Street Journal to inform them of hot stocks based on past performance to make their decisions. By the time it reaches the attention of consumer publications, it is too late to be an early investor/adopter. The stock is now common knowledge.

Unfortunately, that is not what Jordan was saying. He does not give two damns about the clients. He is interested in the financial abuse and assault he and his colleagues can perpetrate on his clients for their own gain. He wants to get the higher commission a penny-stock would pay.

Those stocks pay so much in commission because they need to incentivize brokers to recommend and sell these stocks. This takes more effort on the part of the broker and requires more risk of the loss of clients and reputation. These companies are analogous to a person with no credit or bad credit. The person has to be willing to pay higher interest rates to borrow money. These stocks are willing to pay higher commissions. The same goes for high yield bonds.

In the example of Jordan Belfort’s stock strategy, the client pay’s a certain amount for equity in a company at a 100% markup. In other words, for every dollar the client spends, the company of the stock bought gets fifty cents and Oakmont Stratton gets fifty cents. Plus, Oakmont Stratton probably charges an extra broker or trading fee per client account and transaction. When the company fails and the stock collapses, the only losers are the stock company and the clients. The brokers keep their profits.

The issue with your question is that, in text form, you have not recognized the break in the scene. In the first half of the monologue, Wolfy is talking to his underlings face-to-face. In the second half, he is talking to a client/prospect on the phone, with his minions standing behind him (listening and learning). In the first half, he is pitching his strategy to his Ahabs. In the second half, he is pitching a dog-crap stock to a whale, demonstrating the use of the harpoon. He is playing on both groups sense of greed.

I think you misunderstood, but you do actually hint at the answer in the question:

by the time you read about rising stocks in the newspapers, it is already too late to invest in those stocks to get the most profit

Jordan isn't telling his employees not to invest in rising stocks because they won't make any profit, he's telling them not to because they won't make as much profit as they would if they invested in cheaper, stagnant stocks.

An example to illustrate:

• Investor A buys five shares of Company B for $1 each, paying $5 in total
• Later, as Company B's stocks rise, Investor C buys one share of Company B for $5, the same investment A made
• When Company B's stocks reach $15, A and C both sell. C receives only $15 for a $10 profit, but A's five shares give him $75 for a $70 profit. A and C invested the same money, but because A invested earlier, he made seven times as much profit. Now imagine they'd invested $5 million instead of just $5. C's late investment would have cost him $60 million.

That's what Jordan wants them to invest in stocks before they start rising: so they can make as much money as possible once they do.

Efficient Market Hypothesis

He's directly referring to the efficient market hypothesis. The idea is quite simple: the market has already priced in all available information about a stock into the stock's price. With algo driven trading, this can happen in literal microseconds after the information is released to the general public.

Thus, by the time you have read about something in the newspaper, you cannot hope to make money in the stock market by investing based on that information. This is because that information has already raised (or lowered) the stock price to the level the market thinks it should be at based on that information.

For a real world example, consider McDonalds announcing the new plant based sandwiches. You might think that you should invest in their stock because these type of sandwiches seem to be highly profitable and well received. But all that future profit has already been estimated and has already changed the price of the McD stock to reflect that.

Simply put, under the EMH theory, when you are investing in stocks you should never invest based on information from press releases -- you should be betting that the market as whole has mispriced the stock even after that information has been taken into account. Pro-tip: you will almost certainly be wrong about this, invest in index funds!