Based on the concept of valuation, there are several different types of stock investments. It was Warren Buffet who first coined the term “value stocks” back in 1992.

When buying stocks, you should take time to closely examine their fundamental aspects, such as financial performance, industry prospects, dividends, earnings, profits, company vision and management quality. If the value of the stock is still below its fundamental value, then you are purchasing what are known as value stocks.

There are other types of stocks as well. Prices still reflect the fundamental aspects. Picture a company with a bright prospect that is unfortunately still burning cash. It has a good “story” and its revenue growth is faster than the industry average. It is only a matter of time before it turns a profit and pays dividends to shareholders. If you buy these stocks, you are investing in growth stocks.

When it comes to investing in tech companies, another fairly popular term springs to mind. If you purchase stocks without considering their fundamental aspects: The company is still bleeding money, but you believe in the “story” and the impact it would bring in the future, then you are investing in tech stocks – which are in essence growth stocks.

Retail investors, especially beginners, tend to want to make profits as quickly as possible. They usually do not care what kind of stock they buy. Rumors, trends and analysis easily influence their decision to buy stocks. As a result, they lose money instead of earning profits.

Here is where savviness in stock purchasing comes into play. It does not matter whether they are value stocks, growth stocks or tech stocks, the risk of investing in the stock market often comes from not knowing what stocks to buy.

One popular investment advice is "don't put your eggs in one basket". A diversified stock portfolio will help reduce the chances of suffering concurrent losses. Does the advice guarantee success? Not necessarily.

If your “basket” is to be filled with tech stock “eggs”, then you need to be careful when making your own valuation. Is it worth valuing the "stories" and prospects of these businesses so highly?

Take, for example, a certain issuer that already went public in 2021 with a capital of Rp 10 trillion (US$700 million) and came complete with “stories” about grand plans, hopes and prospects for the future. In just a short time, its valuation soared to more than Rp 200 trillion – an increase of more than 2,000 percent or 20 times its book value. By comparison, the Jakarta Composite Index increase over that period alone was only 8 percent.

A research report even predicted the company’s share price would reach Rp 21,000 per share, but now, with the price of Rp 15,000 per share, a more recent report is predicting the stock to be underweight at Rp 12,000 per share. How is this possible, with the issuer’s business running as usual?

The same is true for other tech stocks. Several issuers of Book II banks and tech-based nonbank issuers also saw high increases in share prices in 2021—from four to six times the initial price – but then experienced a sharp decline in the same year.

This situation should encourage retail investors to reconsider value stocks. That is not to say tech stocks are worthless, but it will take time to prove the promise and "story" offered to investors.

The connection between “price” and “story” can be explained through this case: An entrepreneur is buying 20 hectares of land for Rp 100,000 per square meter. The man says he will build an office building, a hotel, a hospital and a shopping center, as well as apartments and townhouses on the land to establish a "smart city" with digital technology.

Following the "master plan", he then offers Rp 6 million per square meter for the land where the townhouses will be built – which is 60 times the book value.  The most important question becomes: Is the asset’s valuation reasonable? Why is the “story” able to raise its valuation to more than it should be? How long will it take for the investor or buyer to receive a return on his investment if the asset itself is overvalued?

You would definitely pause and think twice before purchasing such an asset. If you decide to push through, the fate of your declining tech stocks will depend heavily on the next investor interested in buying. This is, in essence, what the Greater Fool theory is all about.

Renowned economist John Maynard Keynes first introduced this theory to explain an investment mentality where a person continues to buy expensive assets just because they believe there will be other investors who want to purchase these assets at even higher prices.

Keynes explained in his book The General Theory of Employment, Interest, and Money (1936) that fluctuations in market asset prices are often influenced by emotional aspects. This theory applies not only to stock investments but also to property (real estate). According to Bill Gates, the greater fool theory also applies to cryptocurrencies such as Bitcoin.

The main argument of this theory is that the market price of an asset is determined not by its intrinsic value, but by the expectations of market participants. Share prices are not determined by their fundamental value, but by the belief that other investors will buy the stock at a higher value.

In other words, despite the stock value not reflecting the fundamental value – and maybe even being overvalued – prices can still rise as long as there are “greater fools” willing to buy.

With this theory in mind, as a retail investor, you now have two options when buying stocks that are overvalued. One, if the greater fool buys the stock, then you can sell it and make a profit, or two, you hold the stock until your issuer succeeds in making the "story" they promised you during initial public offering a reality, enabling you to enjoy both its capital gains and dividends in the future.

Hopefully!

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The writer is the founder and chairman of TEZ Capital Group.