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The big fool theory states that in financial markets there will always be someone willing to buy an asset at an inflated price. This theory is often supported by real life stories.
Let’s imagine a girl named Alex, she works in a successful company and receives a good salary. One day she reads the news about an increase in the real estate value. Without researching the market she decides to buy a house, hoping that in a few years prices will rise and she will be able to sell it for a profit.
Here is one example of the great fool theory. Alex makes a decision based only on a short-term surge in prices provoked by a speculative rush. She did not analyze the real value of real estate, did not assess the long-term prospects of the market and the economy as a whole.
A few years later it turns out that the growth was a temporary phenomenon. The house that Alex bought at a high price at the peak of demand has now fallen in price. If a girl wants to sell it, she will not make a profit and will lose part of the investment.
At the same time, far-sighted players who sold real estate during the rush period managed to make money on the emotional and rash decisions of investors like Alex. This fictional girl just fell into that same group of “big fools” according to the theory with the same name.
Today our guest is Vladimir Okhotnikov, a financial analyst, an expert in the field of cryptocurrencies and the author of many analytical articles. His analytics provide valuable information and help ordinary people interested in the world of investing understand complex financial issues.
The big fool theory closes in a vicious circle — Vladimir Okhotnikov on the syndrome of lost profits
The big fool theory creates a vicious circle because people start buying based not on objective reasons, but on the expectation that someone else will buy at a higher price.
Vladimir Okhotnikov believes that euphoria and greed are the lot of inexperienced investors. According to him, this leads to instability in the market, which creates a cycle where each subsequent participant expects prices to continue to rise. The result is an unfortunate situation where decisions are based not on reasonable assumptions, but on the hope that someone else will be willing to pay even more.
The market is predictable in terms of how participants act, says Vladimir. Insiders with information come in first. Then, when the price of an asset rises rapidly, inexperienced novice investors appear and see only growth fueled by the general hype. Without understanding the real value and prospects, they rush to buy an asset at current values.
This is where insiders, who opened positions in advance, begin to fix profits — to “unload”, to sell their goods to the “big fools”, that is, to the crowd experiencing euphoria. Yes, the price starts to fall at some point, but this does not stop beginners. Due to fear of missing out (FOMO), retail traders continue to add assets to the portfolio, averaging trades at a favorable rate.
As a result, only small players remain, holding assets purchased at inflated prices. They are forced to either suffer losses or look for the next wave of “fools” to unload on. This is how a “change of hands” occurs when some people get rid of them and others buy them.
True, the rule of “big fools” applies mostly to speculative instruments and has little relevance to fundamental projects.
Business must make a profit — Vladimir Okhotnikov
Pets.com sold $82.5 million in shares in February 2000, but nine months later it was forced to file for bankruptcy and begin liquidation proceedings.
Once the largest pet supply retailer, Pets.com was founded in 1998 in San Francisco. Despite the fast start and widespread investor interest, the company still remained in the past, ceasing its activities.
Pets.com became famous for its bright and memorable marketing, but despite its initial success and popularity, it faced a number of problems.
“Often goods were sold at a minimal markup, which led to losses. Logistics, the cost of delivering pets and related products, took away most of the profit, but the desire to attract more customers did not stop the management,” this is how a former employee of the company described what was happening.
One of the main mistakes was the desire for rapid growth without ensuring the sustainability of the business model. The company had difficulty attracting new customers and was unable to retain existing ones due to limited consumer loyalty in the industry.
In 2000, just months after a successful initial public offering (IPO), Pets.com announced it would be shutting down. This was one of the largest liquidations of Internet companies during the dot-com bubble.
What happened to those who invested in Pets.com? Some managed to sell their shares, while others were left with nothing.
Inflating indicators means putting business at risk – Vladimir Okhotnikov on crime and punishment
WorldCom occupied second place in the market and was included in the S&P 500. But then the company’s shares fell in price from $64.5 to $0.06, and capitalization decreased by 99%.
In the 1990s, WorldCom was one of the largest companies in the telecommunications industry. However, in 2002 it became known that management deliberately inflated financial indicators by falsifying operating expenses.
One economics employee said WorldCom misallocated more than $3.8 billion in expenses. This was done to ensure that the company’s apparent earnings and their stock price remained high.
After the facts of financial fraud at WorldCom were made public, the company filed for bankruptcy. This made the liquidation procedure the largest in size in US history at that time. It was found that the total volume of fraudulent schemes exceeded $11 billion, which is 5 times the equity capital of Yahoo! Inc (as of 2002).
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Source: Bloomberg
The scandal sparked public criticism and forced lawmakers and regulators to tighten corporate accounting and control rules. WorldCom’s former chief executive, Bernard Ebbers, was sentenced to prison for his role in the scandal.
- Bernard Ebbers, CEO of WorldCom, was sentenced to 25 years in prison for fraud and served time at the Oakdale Federal Correctional Complex in Louisiana. In 2013, business publications Portfolio.com and CNBC included Ebbers on their list of the worst corporate executives in US history. And in 2009, Time magazine named him one of the most corrupt CEOs of all time.
If at that time they knew what kind of fraud FTX founder Sam Bankman-Fried was capable of, they would not have so rashly drawn conclusions about who is the most corrupt CEO. Although Bankman-Fried pleaded not guilty to two counts of fraud and five counts of conspiracy, during the month-long trial, prosecutors were able to prove that Sam had misappropriated $8 billion in client funds from a crypto exchange. He now faces up to 100 years in prison.
Big expenses
Boo.com was one of the first online fashion stores to become famous for offering 3D product renderings. But this did not save them.
The company was founded in 1998 by Swedish entrepreneurs E. Malmsten, P. Hedelin and K. Leander. At that time, Boo.com was considered one of the most original and ambitious projects in the field of e-commerce.
The online store set itself the goal of offering customers a unique online shopping experience. The company quickly attracted attention thanks to its 3D product demonstrations, free consultations and unusual design of its website.
Despite aggressive media marketing, Boo.com faced a number of difficulties. The company spent huge amounts of money on advertising, their website was complex and took a long time to load, which scared off consumers. As a result, the lightning-fast scaling strategy and high costs led to serious financial problems.
Less than a year after opening, the company announced its inability to pay its bills. It became one of the most famous crashes of the dot-com bubble, when many Internet companies struggled to stay afloat due to ill-conceived business models and exorbitant investments.
Conclusion
Pets.com, despite its popularity, was unable to create a sustainable business model, which led to its rapid collapse. WorldCom became an example of corporate financial fraud that led to huge losses for investors. And Boo.com tried to conquer the online retail market with poor marketing strategies and poor management, although it had everything to become leaders in the field of virtual reality (VR).
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