There is an old Wall Street adage called the greater fool theory. This theory states that when you foolishly pay more for a stock than it’s worth, you are doing so on the basis that a fool greater than you will pay you more. Nevertheless, the marketplace is littered with greater fools.
The reason is rather simple. There are times when a stock gets hot to the point that its price rises beyond what fundamentals would dictate the business is worth. Unfortunately, once a stock gets hot, the momentum associated with the rising price tweaks people’s greed. The more the stock goes up, the more people afraid they’re missing something - pile on. For a time this ill-advised strategy appears to make money, until of course the music stops. When this inevitably happens, most people playing this game of musical chairs discover that they have no chair.
Most of the time I present stocks that I believe are attractive research candidates for people to invest in. However, I believe it is also my responsibility to warn people to avoid dangerously overvalued stocks. Stocks become dangerously overvalued when greed overcomes reason. With investing there is no room for emotional responses. Nevertheless, people being human are prone at times towards acting emotionally. The primary emotional responses associated with investing are fear and greed. Both of these emotional responses can be devastating, and therefore, should be avoided. Knowledge is power, and knowledge is associated with logic and reason.
Disclosure: No position at the time of writing.
Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.