The cockroach theory refers to a market scenario in which when a company is facing any trouble then it is likely that other companies in the same sector might be having problems as well. It is predicted that the company which has reported some bad news is most likely to report more negative news in the future. This mechanism is also used to warn investors about the problems in the company. Investors would abstain from investing in companies where they expect more bad news to follow. This may be beneficial to competitive industries as investors may switch from holding stocks from the affected company to other companies. However, since most of the companies are likely to be affected, unloading of stocks may take place by investors which may result in a fatal effect upon the industry.
The term originates from the basic belief that when one cockroach is spotted there is a likelihood for others to follow.
The practicality of cockroach theory is most likely not to occur in companies like Yes Bank and Infosys. Cockroach theory applies to companies which are placed in the same sector industry.
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