Is the stock market a ponzi scheme ? My conclusions

Based on my time in the markets, I will be sharing my experience and some conclusions that I have drawn about the stock market in general. I am also very much open to others opinion about the same topic. Infact I really hope if someone can paint a different picture in front of me as I am willing to be convinced otherwise, but with a sound and rational logic.

First I will try to draw an analogy between the stock market and a ponzi scheme with the following hypothetical, but relatable example-

For the sake of simplicity, we will neglect time value of money, so we will assume what is worth say Rs 1 lakh now will be of same worth even after 10 years.

Suppose there exists 5 magical trees in my garden. Unlike other trees, these grow money on their branches instead of fruits and leaves. The amount of money on any tree at any point of time depends upon the size of that particular tree.

The trees have their own growth rates which depend upon factors such as the amount of water, sunlight, minerals and care they recieve and also upon their internal structure and composition.

Lastly, we can pluck out all money from a tree only after it has completely grown and matured, which is expected after 25-30 years.

Now let’s consider what happens-

  1. In the beginning, lot of my neighbours are bewildered and amazed by these trees in my garden. Many of them also offer me good amount of money in return for owning a percentage or stake of these.

Let’s call the trees A,B,C,D,E with tree A the most promising one to grow into a huge size and E the least promising one. Needless to say most of the offers that come at my doorstep are for tree A.

  1. Suppose the total amount of cash in A after 1 year is 1 lakh and one of my neighbour offers me 10 lakh for 50% stake in A. Also suppose I agreed with the deal. Now as per the new owner, he has valued the tree at a p/e (actually p/b or price to book to be more exact) of 20. He is happy however, as he thinks the growth rate of this tree more than makes up and he will get far more in return after 30 years.

  2. The trees however, have defied the expectations and are growing at much faster rate. New offers are now coming, both to me and the new owner of A, and we both keep entering to new deals by selling our stakes partially. The new owners of these trees in turn also does the same with more new participants.

In these initial years, most participants have still the longer picture in focus- new participants are buying because they expect the reward to be much more after 30 years once these trees grow completely. Likewise old participants who are selling their stakes, sell only when they feel the new participant is erring and paying them more than what the tree should be worth or because of the need for cash.

The primary intention however is still to earn money from the tree itself and not from trade.

  1. Soon that begins to change. After some time, say 10 years, many people from other nearby towns have also become aware of these trees and are trading in the market. Trading also is happening more frequently and there are 1000s of partial owners now of these 5 trees. So far nothing wrong with any of that.

But, the reason why these magical trees have value is simply because years later they are expected to return more money, and thus more the growth more will be their size and hence more will be the money available for distribution. This simple and basic “why” of investing is however started getting lost.

Many of the new investors don’t care about these “whys”. All they know is, there exist some trees whose market price goes up if the trees post, or they are expected to post, good growth rates and their market price goes down if they post bad growth rates. That is all their guide to “how to invest”.

  1. In the next couple of years, the “why” part of the investing is all but forgotten. The intention of many participants now is to earn money from trading- selling their trees to other people, rather than on earning money from the trees themselves. As a result of this, little respect is shown to the valuation of trees.

So even if tree A is still growing at a good expected rate, its price is rising at much faster rate. Its total market value is already above 60 times the amount of present cash, but who cares ?

The odd ones who actually care, their rational voices are dismissed. Price charts and graphs are thrown around casually to justify irrationality. The argument is as long as there is growth, the price should keep increasing because that is what has been happening since past 15 years, so that should also happen in the next 15 years. Doesn’t matter if too much of coming future growths are actually already factored into the current price.

  1. By the 20th year, market value of trees have already reached so high, that many earlier investors don’t think the trees will ever be able to return that much money. The bubble has now started to form.

Some of them try to caution about the extreme valuations, but valuations are subjective they are told by other participants. The best they can do is sell their stakes completely and come out. Not that they would complain anyway, because the current price according to their calculations, is offering better deal than what they would get if they wait for the trees to grow fully.

But is this rational ? Are valuations really subjective ? Maybe yes, but only upto an extent. If an investment is expected to give a return of say Rs 50-80, I can understand if someone wants to buy it for Rs 25 and someone else wants to buy it for Rs 45. Heck I can even understand if someone wants to buy it for Rs 79. But I can never understand if someone buys it for say Rs 200 and then says “valuations are subjective” to justify this irrationality.

In this example however, this is exactly what seems to be happening. For instance, suppose a new investor buys 1% stake in tree A for much overvalued price x. If he never sells his stake, the only way to get return on his investment is from the tree itself, which is suppose say half of that or x/2. So the question is why would this investor buys for double the price ? The answer is, as explained earlier, he doesn’t care about this. He cares about the trading, he knows there will be some other person waiting to buy at even higher price from him. Even though, none of this makes sense.

The underlyings in this case, the trees, even though are wonderful assets but has actually no meaning or value now as compared to the price they are trading at. They are now merely trading assets. So what started as a wonderful tree market has now reduced to a giant ponzi scheme, where 1. The underlying has hardly any meaningful value and 2. The return on one’s investment does not depend upon the underlying asset but upon how much it can be sold to the other person.

I left this imaginary example here, you can conclude yourself what would happen in this story later. Do you think this ponzi scheme or bubble would sustain ? All such ponzi scheme bubbles are actually naturally designed to burst.

This post has already gotten long enough and I apologise for it. I will write my views, regarding whether the stock market is also a ponzi scheme or not, in my next post on this thread. Meanwhile, I hope if you can also put forward your thinking and views regarding the same. Also feel free to point if you think I have done wrong analogy.

P.S. The example above was the best I could think to present my arguments by drawing a parallel analogy between the hypothetical tree market and the actual stock market. It is obviously far from exact.

12 Likes (enjoy the video Jaspal bhatti on stock market)

Having read enough and more books on the subject of Investing (from john burr williams, graham and buffett to lynch, dalio, marks) - I have seen the same evolution in the thought process of these who are considered great investors. The methods of the latter lean more towards quantitative aspects which already diverge from the concept of owning a business. When you have fund of funds, derivatives and high-frequency trades (when the underlying is produced in times that are orders of magnitude higher and traded and consumed in frequencies orders of magnitude lower) - you get the cheshire cat grin (from Alice in Wonderland) that lingers even after the cat vanishes - just layers upon layers of abstractions.

I wouldn’t go so far as to call it a ponzi scheme - for here there can be busts and booms whereas, a ponzi only ends one way - a bust. Its more akin to gambling with odds, perhaps like poker. You make a speculative bet when you buy a stock and in that aspect, all investing is just speculation. I think while everyone waxes eloquent about long-term, everyone is a speculator at heart, wearing the cloak of an investor because its perceived honorable to do so (You can call yourself an investor if you are holding something for the dividends perhaps and enjoy forecasting dividends - liked this idea from the theory of investment value by JBW)

As for the irrationality of bidding up prices to a bubble, I don’t think its irrational at all - It is what game theory calls “bounded rationality”. Everybody knows what everybody knows but the game can go on until everybody knows that everybody knows - and that can be awhile and it can be terribly interesting. Don’t miss out.


I can’t conceive of any situation in which the Stock Market can be seen as a Ponzi Scheme.

Let’s say I buy a company I like at a price I think is reasonable. If trading in the stock stopped abruptly, I would be perfectly happy to hold it for years on end. One fine day, even if just 2-3 folks want to take it off my hands with a Private contract, I’d still realize my gains. This doesn’t consider Dividends or Buybacks, which will obviously be an added bonus for the time I’m holding the Stock.

What the Stock Market does is provide liquidity - lots and lots of it. But even without liquidity, Stocks hold Value. A Ponzi Scheme would crumble the moment funds stop coming in (i.e. Liquidity stops).


I think share market frauds like the ones happening every other day with huge institutions like yes bank,DHFL,ILFS, SINTEX etc etc are worst than Ponzi scheme because these institutions are run by highly educated professionals, have visibility as a going concern for decades, are regulated and monitored by various bodies, audited and have independent directors too.Therefore investors of all sizes by and large trust their working. On the other hand, Ponzi scheme can be smelt by most of smart investors and people of meagre means ,or looking for overnight growth get lured to Ponzi schemes.
However the continued failure of companies having huge market caps say 50000 crs with utter failure of various monitoring agencies, independent directors, implicit involvement of auditors gave shattered faith of investors time and again.
Unless drastic steps are taken against these swindlers quickly and money swindled is gorged out of them ,the retail investors will lose interest in stock market .

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The premise of a Ponzi or pyramid scheme is completely dependent on contribution from new members to create value for the existing members and not based on any thing of value to start with. You started with a a magical tree that bears Money and people bet on its future value. If the magical tree is not real then of course it’s a ponzi or a con. But if it does have an underlying value then the situation that you described in the second part is more like a asset bubble ( tulip mania) than a ponzi. At the end of bubble the asset doesn’t disappear but just it’s price gets more realistic. Thus an HDFC bank stock may fall by half but it still holds value due to its underlying business which creates long term value. An investment in a stock may appear like a ponzi as long as we don’t attempt to understand it’s value. While I disagree with your conclusion I appreciate you sharing it with us and letting us reflect on it from a different point of view.


I might be completely wrong here this is my theory.

The companies go bust will have one or other way some political connection. Now that in India corruption and scams are impacting political parties in big way, how do they fund elections, support their party supporters. By crony capitalism, legally help the businesses to become established by policy favors and not enforcing laws on violations. In return these companies take loans from banks (depositors money/capital), not actually invest in running businesses but siphon it off for political funding, finally default and apply for bankruptcy. None gets caught but becomes a legal. See all names like DHFL, YES BANK, ESSAR, ADAG, PMC hard to believe they lost money by doing fair business. DHFL and YES post elections.

Take my theory with pinch of salt.

Unless government/courts punish the ones (entire cartel) behind these bankruptcies legal defaulting will continue making it look like ponzi schemes.

In my opinion, whether the scheme is ponzi or not depends on the position of the person viewing it and deriving the perspective.

  1. The tree is still there and it’s value exists for a person who has invested initially and who continues to remain invested and invest further keeping this in mind. The scheme is not ponzi for this person.

  2. It is also not ponzi for those who are trading at high valuations as they think it can be sold at even high valuations.

  3. For a person looking from a neutral perspective and who perhaps does not intend to invest or remain invested, it may appear ponzi noting the way the scheme has evolved over time. for instance the IT bubble burst in 2000 and real estate burst in 2008.

The scheme will be truly ponzi if there was never a tree in the first place and the valuations were created out of thin air.

  • Ashish

Thank you for this very thoughtful post, @Abhishek16.

You’ve raised a very valid point. I think the most relevant thing which comes to mind is John Burr William’s “Theory of Investment Value” which argues that as an investor, it only makes sense to pay for a business the sum total of the discounted future dividends. Anything else in William’s opinion is speculation.

I repeat, DCF is speculation. Rule #1 investing (Phil Town) is speculation, low P/E is speculation, low PEG ratio is speculation. But at the end of the day, some speculation just has higher chances of working due to a limited down-side compared to the upside. As “modern day investors” our aim is to find methods of buying stocks in such a way that 10 years from now, someone would definitely want to buy it at a price which has compounded higher than inflation + a margin of safety (to cover the equity risk).

Those are my 2 cents.


Why restrict this to the stock market? There is a strong case that could be made that our entire financial system (concept of fiat money) is a ponzi scheme. We are constantly “borrowing” from future growth. Just like a bank run can crash any bank (even the much loved HDFC Bank cannot survive a truly paranoid bank run), a loss of faith at a large enough level can crash any financial system. There are built-in assumptions of growth and productivity improvements in all financial systems. If that does not hold good (or even if faith wavers), it can all come crashing down like a pack of cards. So far, human ingenuity has kept the productivity growth assumption valid. Even if that continues, loss of faith can crash systems. And if growth / productivity itself stops, then there is almost certainly no escape. As one of the largest companies in India rightly puts it, growth is life. And I truly hope and pray that both the growth and the faith hold strong.


Here is the dictionary definition of a ponzi scheme- scheme in which funds paid in by later investors are used to pay artificially high returns to the original investors, thus attracting more new investors and inducing earlier investors to venture even more money.

The assets can be totally non-existant or have little value as compared to their price, you can call it asset bubble, not going into its semantics, but what I wanted to convey was how participants approach market as if it were a ponzi scheme.

In my example above, after some time, the trees were merely trading assets. Just like in a ponzi scheme where people do not care about the underlying asset, the intention is to earn money from trade only.

Also, I never said that the stock market is also a Ponzi scheme. However, a lot of participants does approach it like that. I will write my thoughts in more detail regarding this sometime later.

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Excellently articulated!! Take a bow :bowing_man:

I looked at Enterprise Values and Cash Flow generation (CFFO, FCF) of some stock market darling stocks (established and stable companies which are not into heavy investment phase) and wondered who will pay such an astronomical amount (EV) for buying a business which generates such paltry cash flows.

All I heard in return of this question was - "there are no comparable companies in this space" and “quality comes at a price”.
My hitherto unspoken response to this is “its financially far more prudent to buy LIC Jeevan Akshay VI than to own a fancied stock whose valuations make no common sense”.

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In the analogy above, if (and I am quoting relevant part in a way I understood)

  1. No time value of money
  1. Trees that keep growing money
  1. At some tangible rate

Thus against no time value of money, you have a tree that keeps growing money. So that value of the tree today should be infinity in terms of that money.

So people will not be irrational to pay any amounts of money to buy a stake in that tree because they have finite money and a growing tree, even if they trade all their money for a slice of it, it will grow to infinite money. Actually even if there is no growth but constant produce of money, the value will be infinity if there is no decadence of money over time.

Ofcourse analogies have their limitations and I understand that, and the assumption of no time value of money is quite untenable. Money will then start to lose value.

In any case the tree reminded me of some central banks that kept printing money. The Reichsbank during the Weimar republic is a well documented one, and money’s purchasing power went down.

Hi @diffsoft

There is one crucial aspect you missed. The trees will continue to grow only upto 30-35 years, So no there will not be infinite amount of money on them.

OK, maybe that’s what you meant here:

I assumed ‘matured’ to be not growing but that plucked money gets replenished…aka a tree bearing fruit. Analogies are useful but also misleading. I guess this scenario is a litle too hypothetical for me.

Obviously, but in real world, most of the companies, after maturing, grow at a rate which is not much higher than inflation.