First of all, let me disclose that I love Facebook. It’s a great medium, and I use it to communicate with many family and friends, and keep up with long lost acquaintances from high school and college. And let me also disclose that I have absolutely no idea what is the “true value” of its stock. There are so many scenarios that can happen to drive its value up or down, and a valid case can be made for its value being anywhere between $5 and $100 per share. I suspect that the main difference between me and the analysts who were touting Facebook’s IPO is that I admit that I have no idea what it’s actually worth.
However, on the day it went public, there I was on live radio, being asked my opinion about Facebook. I gave what I thought what was an innocuous answer –academic research shows that, in general, IPOs are over-hyped, and therefore overpriced, and smart investors should stay away from them until they have seasoned (as an aside, I suspect that overpricing is greater for companies that have been the subject of a major motion picture). And now, in subsequent interviews, and client meetings, I have been credited with making the right “call” on Facebook. Well, I would like to say I owe it all to clean living and a healthy diet, but in actuality, I had a 50-50 chance of being right in the short-term, and I believe that investors should not make a decision, nor evaluate a decision, based on a short-term time frame.
However, over the long-term, in addition to the academic research, there is a more fundamental reason why I would warn investors off of an IPO. The buying of individual stocks is a risky and highly competitive business. You may be a smart person, but you are entering into a competition in which there are literally millions of other smart people participating. And many of those competitors are true professionals, with years of education, training, and experience, and teams of colleagues spending all of their working time analyzing stocks with sophisticated quantitative models at their disposal. Remember that if you are buying a stock, someone else is selling it, and thousands of others are considering buying it, but have chosen not to do so at that high of a price. So you have to ask yourself, why are you smarter than everyone else in the competition? It’s the same issue when you are selling a stock – there is a buyer, and thousands of other holders choosing not to sell. As an alternative, you can participate in the completion more passively, by investing in a well run mutual fund, where you are teaming up with professionals instead of battling against them.
So, this begs the question – why, in this day and age of the capital market, where there are thousands of mutual funds and individual portfolio managers with relatively low fees, do any investors buy individual shares of stock? Part of the answer is hubris – despite the odds I laid out above, some people’s egos still cause them to believe they know better. But I think a more descriptive answer is because they are “social investors” – they invest in individual stocks because there is enjoyment in the process of talking about their victories. In those conversations, there is likely a lot of selective memory happening – successes are being carefully analyzed, and failures are consciously or sub-consciously being forgotten (similar to when I am discussing my athletic performances as a youth). I enjoy doing many things for social reasons, but investing my portfolio is not one of them.
So go ahead and post on Facebook, eat at Joe’s Crab Shack, buy a cell phone with Audience technology, and have a latte at Koffee Korner. Just be wary of investing in their IPOs.