GREATER FOOL THEORY

Aug 09, 2017 12:57 PM IST | Source: Moneycontrol.com

The bull market & ‘Greater Fool Theory’! Shell companies rose up to 200% in 2017

According to the theory, the price of an object or a security is not determined by its intrinsic value, but more by the irrational beliefs and expectations of market participants.

ByKshitij Anand

The Indian market saw a euphoric rise in 2017 which not just took the index to new highs but a lot of small, and penny stocks to even greater highs. In a move to safeguard investor interest, SEBI earlier in the week banned trading in over 300 companies.

Some of these companies are well known and common among the trading community. The move to ban trading in 331 stocks have impacted about 36 lakh investors who hold nearly Rs 9,000 crore, some media reports quoted.

These include some big names, such as Rakesh Jhunjhunwala, DSP Blackrock, HDFC Mutual, Reliance Mutual and UTI among domestic investors, it said.

But, there is a bigger theory at play which might have prompted SEBI to initiate such a strict action. One of the analysts said that it might be the ‘Greater Fool Theory’ at play, and this is common in a bull market.

“Out of the entire list of 300 companies, I have only tracked 3-4 companies and what SEBI has done is exactly what the doctor ordered. In a bull market, all these shady companies have started to rally and there was a complaint to SEBI that investors are getting SMSs from various brokerage firms to invest in them,” A.K.Prabhakar, Head -Research at IDBI Capital told Moneycontrol.

“These kind of things are normal in a bull market and it call the ‘Fools Theory’ – who is the greatest fool. A person knows that it is a shady company which I will buy and will try and get a greater fool than me to buy it at even higher price,” he said.

Also Read: Here's the list of 331 shell companies that SEBI imposed trading curbs on

So, what does the theory say?

According to the theory, the price of an object or a security is not determined by its intrinsic value, but more by the irrational beliefs and expectations of market participants. A common sign sees in a bull market which is flushed with liquidity.

The greater fool theory is the theory that states it is possible to make money by buying securities, whether overvalued or not, and later selling them at a profit because there will always be someone (a bigger or greater fool) who is willing to pay the higher price, according to Investopedia.

Prabhakar further added that investors who bought the security and then advertise it on social media such as Twitter, Facebook, or chat groups and innocent investors get caught.

If we look at the list provided by SEBI, there are no companies from the BSE 500 list and care should now be taken to focus on quality rather than just the price, he said.

Massive return already seen in 2017, but hard to exit now:

Some of the companies named by SEBI include Prakash Industries, SQS BFSI, Parsvnath Developers, Pincon Spirit, Gallantt Ispat, J Kumar Infra, Prime Capital Market, Dwitiya Trading, Adhunik Industries and VB Industries.

Prakash Industries rose 207 percent so far this year, has a strong balance sheet, followed by Parsvnath Developers gained 82 percent, Pincon Spirit rose 11 percent, while J Kumar Infra rallied 38 percent in the same period.

Trading in these securities shall be permitted once a month (First Monday of the month). Further, any upward price movement in these securities shall not be permitted beyond the last traded price and additional surveillance deposit of 200 percent of trade value shall be collected form the Buyers which shall be retained with Exchanges for a period of five months.

SEBI further added that the exchanges shall initiate a process of verifying the credentials/fundamentals of such companies.

The exchanges shall appoint an independent auditor to conduct an audit of such listed companies and if necessary, even conduct a forensic audit of these companies to verify its credentials/fundamentals.