Your Three Total Wealth Tactics to Play Any IPO
Fitness device phenomenon Fitbit Inc. (NYSE:FIT) IPOed last week and promptly shot up nearly 50% on its first day of trading, causing a media frenzy that excited a lot of investors. Still more were left lamenting the fact that they weren’t along for the ride.
Trust me… you don’t want to be.
The Fitbit IPO highlights everything wrong with Wall Street today. Worse, it’s set up to make you fail while insiders get rich. That’s why rushing out to buy shares is the very last thing you want to do when a stock like this begins trading.
Still, not all IPOs are bad news.
Here’s what you need to know about today’s IPO culture so you don’t get burned.
IPO stands for “Initial Public Offering.”
It’s a process that used to be a badge of honor for companies that had been in business long enough to merit the public’s trust, and it dates back to the Roman Republic of 509-527 B.C.
The Roman version of today’s joint stock companies were called publicani, and they traded in an over-the-counter market by the Temple of Castor and Pollux near Rome’s Forum. Shares attracted quaestors, or speculators who bought and sold based on their assessment of a publicani’s business acumen.
Now, though, IPOs are very different.
Today, they’re little more than a get-rich-quick scheme that’s so heavily stacked against you that it makes the house odds in Vegas seem downright conservative.
I say that because you are literally the last in a long line of people who are going to profit from the IPO process. That surprises a lot of people who think getting in on an IPO is tantamount to being one of the earliest investors.
The IPO process is now a rigged game – one in which the founders, the early angel investors, venture capitalists, and the investment bankers all make out like bandits. They don’t give a rat’s you-know-what about whether you make money. Only that you buy enough shares to pay them off.
Forget Profit Forecasts – Here’s What IPO Hustlers Really Care About
What matters to each of the parties I’ve just mentioned is that you believe the hype surrounding a newly minted public company because that ensures a high enough IPO valuation that they all stand to make hundreds of millions or even billions of dollars when shares start trading.
In the old days, companies IPOed based on real results and proven success. Now companies are brought to market based on “potential.”
Pets.com was supposed to change the world. It’s gone. Kozmo.com and the online delivery model… gone. WebVan? Gone. Dr. Koop? Gone.
This is what makes the IPO process so dangerous – companies that raise money selling common shares via an IPO are never required to repay capital to public investors, i.e. YOU. There is no recourse if you buy into one and it heads south.
Again, I know IPOs are tempting. In an era where people remember Google, Microsoft, Apple, and the billions those companies have created for early investors, who wouldn’t want to strike it rich overnight?
- Fitbit’s founders, James Park and Eric Friedman, were instantly worth $600 million.
- Mark Zuckerberg raked in a cool $1.15 billion by selling less than 6% of his shares and options during Facebook’s IPO.
- Alibaba’s Jack Ma made $800 million from selling shares the moment Alibaba started trading, even as the stock’s gains pushed his net worth to more than $16 billion.
Wall Street’s made plenty, too. Investment banking fees typically run 3-6% for a major deal on U.S. exchanges. In 2014 alone:
- Goldman Sachs took home $4.7 billion in IPO-related investment banking…
- JPMorgan came in just a notch over $4 billion…
- Morgan Stanley grabbed $371 million….
However, there isn’t a similar list for individual investors who bought in at the IPO when shares started trading, which ought to tell you something.
Nobody wants to highlight what a disaster IPOs are for individual investors. But there are charts of what happened to them…
The chart below shows the fates of four highly touted IPOs that were all media darlings in their day. Note that all of them fell by double-digit percentages after an initial bounce following their IPOs a few years back (or in the case of King Digital Entertainment, a 22% drop since its debut 17 months ago).
Sadly, many investors are familiar with Groupon, the group’s worst offender. It’s lost more than 76% since November 2011 when shares began trading.
Of course, Groupon’s IPO did make a few people very happy; of the $946 million the company raised in its last round of venture funding, $810 million went towards buying shares from insiders, leaving only 14% of its funding dedicated to help the soon-to-be-public company claim its place in the tech sector.
Ironically, the only insider that can be thankful not to have been granted access to Groupon is the only company whose money was turned down. In 2010, Google offered $6 billion to acquire Groupon, which the upstart company rejected because it perceived its valuation as being higher. But today Groupon is valued at just $3.6 billion.
But, but, but… “things will be different this time,” goes the rally cry.
No. They won’t.
IPO Investors Can’t Wish Away Fitbit’s 50% Failure Rate
To echo comments from MarketWatch columnist Tim Mullaney, Fitbit “doesn’t do much that matters.”
It’s hype – pure and simple.
Fitbit is a one-trick pony intended to measure your fitness with an emphasis on heart health. That sounds promising, considering that 600,000 Americans die from heart disease every year. In reality, though, less than 1% of Americans under 40 have heart disease and only 6% of the people under 60 do.
There are 19 million registered Fitbit users according to the company, approximately 9.5 million of whom are active users. That tells me roughly 50% of the people who have tried the devices, which range from $23 to $250 in price, got bored and threw them into a drawer with other useless electronic devices, never to see the light of day again. We all have a drawer like that.
This reminds me of Twitter, where nearly a billion people have tried the service… and left.
According to University of Pennsylvania researchers Mitesh Patel, David Asch, and Kevin Volpp, only 1-2% of adults own wearable fitness devices, and fully one-third of those users stop using them after six months. Less than 10% of Fitbit owners wear the gadgets daily, according to PricewaterhouseCoopers.
Fitbit is a fascinator and nothing more. It doesn’t tell you anything new. You don’t need a $250 piece of fitness jewelry to tell you that you scarfed that extra donut, skipped the treadmill, or didn’t sleep well last night.
But the worse thing, in my opinion, and the number one reason why devices like this are a terrible investment, is something much more nefarious.
New regulations under the Affordable Care Act, aka Obamacare, give companies incentives to manage their employees’ health. One of the ways they do that is by selling your private health data.
That’s right… wearable fitness trackers open the door to employers gaining information on your health that shouldn’t be in your personnel file. And that, in turn, means your insurance company isn’t far behind. Nor are your premiums.
Three Rules to Take Wall Street’s Weapons Out of the IPO Equation
So how do you profitably play an IPO?
There are three Total Wealth Tactics that apply.
- Wait until the euphoria has passed and the insider lockup period is over. You want to give the institutional traders time to separate nervous traders from their money. Then, average in over time if you want to own shares.
- Make the company prove that it merits your money and your trust. That usually takes a few quarters. The reason is simple. IPO hype is based on what “could be,” not what “is.” Many times management cannot make the jump, and you do not want to pay the price for finding out which is which.
- Use lowball orders to get the price YOU want. It’s always better (and more profitable) to name your price and have the market come to you than to try and chase a hot trade. Temptation is the most powerful of all emotions, which is why Wall Street hypes IPOs the way they do.
In closing, people tell me all the time that they hate missing out on a good thing when they see a stock running higher, especially when it comes to an IPO.
You can buy later when the company you’re interested in is more stable and you risk less for doing so based on cold hard analysis, proven management and, chances are, good old-fashioned profits.
Until next time,