Investing wisely in Kenya
The greater fool theory simply states that individuals will always price items not by its actual value but by the belief that they can sell the given item to another individual at a higher price. The theory assumes that all market participants are fools and one only needs to find a greater fool than himself/herself to make an arbitrage profit.
The theory applies to most of our economic decisions which may seem sound at the moment of making but may be disastrous in the near future. To put this into perspective, I will highlight scenarios that have affected the Kenyan economic market and how the greater fool theory was applied in those cases.
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To kick off, we will analyze the quail farming mania. The quail farming mania hit the Kenyan market in early 2014 when all broke loose and the general population shifted their investment and savings into quail farming. Nutrition value of the quail egg was the underlying principle of the high expected returns from the quail farming business which attracted most Kenyans.
The greater fool theory is in effect here when we consider the price of a quail egg at the peak of the quail farming mania. Quail eggs were selling at Kenyan shillings 100 per egg due to high demand form the market. Looking at the price, people were interested in the high expected return from selling the eggs rather than having a sound business plan. Deeper analysis of the business plan would have highlighted the flaws in this business concept. The said high demand in the market resulted from new quail farmers looking for seed eggs to build their farms rather than real market demand from consumers of the product. Once the farmers had accumulated enough eggs to start selling to the real consumers, supply had already outstripped demand making the price plummet from Kenyan shillings 100 per egg to Kenyan shillings 20 per egg.
Next we can look at initial public offerings (IPO) of companies in the Kenyan market. An initial public offering is when a company is first listed on the stock exchange. This is done by issuing shares of the company to the general public through a stock broker. To elaborate clearly, we will focus on Safaricom IPO haze which occurred during the 2008 financial year.
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Safaricom IPO was recorded as the biggest IPO in Kenyan history with an oversubscription of over 350%. It would seem mad to think that the greater fool theory may have applied in this case but taking a step back and analyzing the figures, the Kenyan mentality of flocking to the newest hype in town clearly reveals itself here. Looking at the oversubscription, everyone was buying Safaricom shares during the IPO expecting to sell the shares at a higher price. The extent was so much that some individuals took out loans from banks to purchase the shares. Most of the individual investors did not analyze the future cash flows nor did they seek advice from any relevant institutions on the prospective future of the company.
The big question here is if everyone was buying, who were they expecting to sell to? The supply was greater than the demand making the shares trade lower than Kenyan shillings 5 which was the IPO price for close to five years. Shareholders had to be stuck with their shares waiting for the price to rise above their initial purchase price. One may argue that Safaricom shares are trading at Kenyan shillings 15 now, but most individual investors have minimal capital to hold a position for such a long time and most probably they opted to sell at a loss.
Pyramid/Ponzi schemes are other examples of application of the greater fool theory effect. A pyramid/ ponzi scheme is a system where an individual or organization pays returns to existing members from capital acquired from new members rather than from profit earned from running the business. The system is sustainable as long as new members continue to join the group or organization which usually offers promise of extremely high returns.
Many Kenyans have been lured into investing in such schemes with the promise of extremely high returns. The first few individuals receive high returns prompting them to invite other participants to the group. As the group grows bigger, higher and higher returns are required to keep the members happy. Eventually the group collapses leaving most of the participants at a loss since there was no business concept in the first place.
Last but not least we can take time to look at the Kenyan real estate market especially around Nairobi. The Kenyan real estate market has been on a boom since early 2010 making Kenya to be ranked top five worldwide in terms of returns on real estate. The flawed assumption that land will always appreciate hence value of houses will also appreciate was the underlying concept behind the 2009 financial crisis but as always we never seem to learn.
Most Kenyans are now buying real estate with the presumption that they will sell the land at a higher price. This is a true classical application of the greater fool theory since individuals are not looking to buy land and develop it to generate cash flow that can repay the purchasing amount and earn a profit. I am not saying that it is not possible to earn a profit by buying land and holding it to sell at a higher price, what I’m saying is that what if you are the last person at the end of that chain? Wouldn’t it be more prudent to buy land knowing that even if you won’t find a buyer, you will be able to utilize the land and generate meaningful cash flow that is profitable and sustainable?
You might think that the greater fool theory does not apply to you but I’m sure you have fallen for it once or twice in your life if you can objectively analyze your past financial decisions. The point that I am trying to get across is that you should not fall prey to the crowd mentality. Think very objectively about your financial decisions and avoid getting high with the expectation of a greater profit from less hard work lest you become the greater fool in the market.