Be honest, Google (Nasdaq: GOOG) investors. A lot of you out there didn't buy Google because you thought it was undervalued. You knew it was overvalued. You knew that, in paying $85 a stub for a company that is worth at most half that, you were being suckered. But you bought anyway, in hopes that after the IPO, a "greater sucker" would come along and take your shares off your hands, leaving you with a tidy profit (lucky for you, he did).
It's called "the greater sucker theory of investing," and it's the basis of a lot of the kind of "investing" that goes on during bull markets like the one we saw in the late 1990s and like we are still seeing now. Faux traders, calling themselves "investors," buy shares of media darlings such as Enron, Ciena (Nasdaq: CIEN), WorldCom (now MCI (Nasdaq: MCIP)), Xybernaut (Nasdaq: XYBR), or Lucent (NYSE: LU) not so much because they understand the company's financials and can objectively argue that the company is a good investment, but rather because the stock is "hot" and "is going to $20 by December."
Of course, whether the stock goes to $20 by December or not, the trader couldn't care less, because he'll have flipped it over to a greater sucker by next week.
While writing up my story on ARM Holdings' (Nasdaq: ARMHY) buyout of Artisan (Nasdaq: ARTI) yesterday, I got to thinking that there is a flip side to the greater sucker theory. It goes like this: A very bright person takes a look at what, by all objective metrics, can be described only as an overvalued equity. After running a discounted cash flow analysis, comparing the company with its peers' valuations, and making a reasoned examination of the company's business prospects, this investor shorts the stock.
This short seller is hoping that, ultimately, the market will realize the error of its ways and the stock will sell off. At that time the short seller plans to close his short and pocket a tidy profit. But you know the saying about best-laid plans. Every once in a while, apocalypse strikes. For instance, individual investors aren't the only people who can get lulled into buying an overvalued equity. Sometimes, an entire company can do the same thing. Sometimes, the company whose stock you short gets a buyout offer at a premium. It happened to short sellers of Artisan on Monday. It could happen to other short sellers tomorrow, and the prospect probably has them quaking in their boots.
Call it "the fear of a bigger sucker."
Fool contributor Rich Smith
owns no interest in any of the companies mentioned in this article.
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