Phunware (NASDAQ:PHUN) is a software company that saw its shares skyrocket in October, going from under a dollar on Oct. 1 to a high of $24.04 on Oct. 22. This was followed by a dramatic selloff, opening at $4.16 on Nov. 8. PHUN stock is a clear example of the greater fool theory.
Phunware provides some information on its website: “Phunware is mobile software that exhibits gamelike mechanics and behavior so brands can contextually engage customers and drive digital transformation.” Its goal is to help other businesses achieve more so that “brands can get the right content to the right customer at the right time in the right place.” That all sounds interesting, but PHUN stock is a perfect example of bad investment thinking.
The Greater Fool Theory
Investopedia offers this summary of the greater fool theory:
“The greater fool theory argues that prices go up because people are able to sell overpriced securities to a ‘greater fool,’ whether or not they are overvalued. That is, of course, until there are no greater fools left.
“Investing, according to the greater fool theory, means ignoring valuations, earnings reports, and all the other data. Ignoring the fundamentals is, of course, risky; and so people subscribing to the greater fool theory could be left holding the bag after a correction.”
The greater fool theory is inevitable as investors treat the stock market like an online casino. By ignoring fundamentals, investors buy into the thrill of quick profits in stocks that are otherwise not worth it. Investors also tend to follow the herd, simply doing what they see others doing.
It’s easy to fall back on instinct, but it’s a risky strategy. In the majority of cases, the clock is ticking on these risky investments made without any real justification. In cases such as PHUN stock’s huge volatility in October, investors decide that the asset’s intrinsic value is much less important than the increase in the observed demand.
As long as PHUN investors believe they can find other people to sell the stock to at an even higher price — as long as the greater fool continues to exist — then everything works out as planned.
However, the stock market tends to correct this sort of speculation, resulting in a transfer of wealth from unsophisticated investors to the so-called “smart money.” The meteoric rise is followed by a dramatic selloff with many losing their entire investment.
Investors who bought PHUN stock at its peak have now lost about 83%. You can avoid falling prey to the greater fool theory by starting with due diligence, applying common sense and having discipline.
Avoid PHUN Stock
The PHUN stock rally was tied to the fervor around former President Donald Trump’s Truth Social, which is merging with Digital World Acquisition Corp. (NASDAQ:DWAC), a SPAC (special purpose acquisition company). The company played a role in Trump’s 2020 campaign: “Phunware was responsible for building the app Trump used to communicate with and track 2.8 million of his supporters.”
It’s possible that Phunware could operate Truth Social. But it’s just a rumor right now. And of course, DWAC investors should be very cautious too. It is a questionable investment at the lofty price of $58 at the start of Nov. 8.
As for Phunware, the company is losing money. It saw its revenue decline almost 50% in 2020 compared to 2019, with negative cash flows from operating activities and increased positive cash flows from financing activities due to stock dilution. With reported revenue of $10 million for 2020, Phunware is trading at 30 times revenue with a market capitalization of $356 million. The fundamentals are not good. Investors be very cautious with PHUN stock until some key catalysts appear.
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On the date of publication, Stavros Georgiadis, CFA did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Stavros Georgiadis is a CFA charter holder, an Equity Research Analyst, and an Economist. He focuses on U.S. stocks and has his own stock market blog at thestockmarketontheinternet.com/. He has written in the past various articles for other publications and can be reached on Twitter and on LinkedIn.