Category: Best Of

All stocks start with an IPO. It is a well known fact that some of them build their investors an enormous wealth over time. $SBUX for example is up 7800% since its IPO 20 years ago. $PNRA is up 2450% since its IPO 11 years ago. There are countless other examples, but is buying on the IPO day a wise choice?

For most retail traders, who by default don’t have access to initial offerings, blindly buying IPO stocks when they become available is a losing proposition.

You have to understand the incentives behind IPO offerings. There are so many willing suppliers of stocks: from the VCs, who want to bring back some money after years of waiting; to employees, who are in a hurry to taste their newly acquired wealth; to investment banks that are looking for a quick flip. This is why, most new issues are not a good investment during the first 6 to 12 months of their existence, when the lockup period expires.

If you take a look at the charts of most of the long-term big winners, you would notice that the majority of them didn’t have any traction in their first year of becoming a public company. There are some rare exclusions, like $GOOG for example. The odds of investment success are better if you wait out the first 6 to 12 months and buy as a stock is breaking out to a new all-time high, preferably with earnings catalyst behind the move.

Most new issues might not be a wise investment, but many have proven to be perfect trading vehicles due to their underlying nature – small float and intriguing story, which fascinates the mind with its potential, encourages the dreams of future profits and gets all the press attention. As such, they could offer great short-term trading opportunities.

Make sure you don’t overstay your welcome. It is perfectly appropriate for many of the new stocks that go up substantially in a short period of time, to issue secondary offerings and dilute current shareholders. Wall Street is a printing press and a marketing machine. It carefully gauges the health of the market and the current appetite for certain industries and at the end of the day, it offers what the market desires. The supply is unlimited.

Here is my list of the hottest IPO issues of the past year: $INVN $UBNT $IMPV $BODY $BCOV $JIVE $ZNGA $FRAN $KORS $TEA $TNGO $FIO

Let me know if I missed any, deserving my attention.

1. People usually expect the future to be like the past and underestimate the potential for change.

2. When everyone believes something is risky, their unwillingness to buy usually reduces its price to the point where it’s not risky at all. Broadly negative opinion can make it the least risky thing, since all optimism has been driven out of its price.

3. In investing, as in life, there are very few sure things. Values can evaporate, estimates can be wrong, circumstances can change and “sure things” can fail. However, there are two concepts we can hold to with confidence: • Rule number one: most things will prove to be cyclical. • Rule number two: some of the greatest opportunities for gain and loss come when other people forget rule number one.

4. Very early in my career, a veteran investor told me about the three stages of a bull market. Now I’ll share them with you. • The first, when a few forward-looking people begin to believe things will get better • The second, when most investors realize improvement is actually taking place • The third, when everyone concludes things will get better forever

5. Investors hold to their convictions as long as they can, but when the economic and psychological pressures become irresistible, they surrender and jump on the bandwagon.

6. Even when an excess does develop, it’s important to remember that “overpriced” is incredibly different from “going down tomorrow.” • Markets can be over- or underpriced and stay that way—or become more so—for years.

7. If everyone likes it, it’s probably because it has been doing well. Most people seem to think outstanding performance to date presages outstanding future performance. Actually, it’s more likely that outstanding performance to date has borrowed from the future and thus presages subpar performance from here on out.

8. Our goal isn’t to find good assets, but good buys. Thus, it’s not what you buy; it’s what you pay for it.

9. There are two kinds of people who lose money: those who know nothing and those who know everything.

10. One way to get to be right sometimes is to always be bullish or always be bearish; if you hold a fixed view long enough, you may be right sooner or later. And if you’re always an outlier, you’re likely to eventually be applauded for an extremely unconventional forecast that correctly foresaw what no one else did. But that doesn’t mean your forecasts are regularly of any value

11. Surprisingly good returns are often just the flip side of surprisingly bad returns. One year with a great return can overstate the manager’s skill and obscure the risk he or she took. Yet people are surprised when that great year is followed by a terrible year.

12. Psychological and technical factors can swamp fundamentals. In the long run, value creation and destruction are driven by fundamentals such as economic trends, companies’ earnings, demand for products and the skillfulness of managements. But in the short run, markets are highly responsive to investor psychology and the technical factors that influence the supply and demand for assets. In fact, I think confidence matters more than anything else in the short run. Anything can happen in this regard, with results that are both unpredictable and irrational.

Source:  “The Most Important Thing”, Howard  Marks, 2011

Apple, the stock and the company, is everything but not typical

Most momentum stocks go through 3 main stages:

1) Earnings growth leads price growth. There is sudden acceleration in earnings growth that starts a process of repricing, but most investors are still cautious with the new name. They either don’t trust the sustainability of the story yet or haven’t heard about it. This period could continue anywhere from 6 months to 2 years. (think in terms of Hansen Natural in 2004 – 2005)

2) Price growth leads Earnings growth. At this stage the stock and its story are widely known and understood. The market projects the current levels of growth into infinity and it proactively discounts the best case scenario. This stage typically continues anywhere from 6  to 18 months. (think in terms of $MNST in 2006 – 2007 or $NFLX mid 2010 to mid 2011)

3) Either price growth and earnings growth start to go hand in hand or price growth drops below earnings growth ( as it is often the situation with ex- momentum leaders)

As you can see from the chart above, $AAPL is not following this pattern. While its market cap has increased 46 times for the past 10 years, its earnings per share growth has been even more impressive – 130 times. The EPS growth was offset by a 60% decline in the P/E multiple that the market is willing to pay. P/E often reflects investors’ expectations for near-term growth. As Nicholas Darvas liked to point out:

It is the anticipation of growth rather than the growth itself that leads to great profits in growth stocks. The biggest factor in stock prices is the lure of future earnings. The dream of the future is what excites people, not the reality

Walmart’s shareholders have experienced that personally. Over the past 10 years, $WMT’s EPS have more than doubled, while the market cap of the giant retailer fell 21%

The law of big numbers’ effect is commonly known and it is already discounted

For more than three years, investors have been pointing out that the gigantic size of Apple will limit the pace of its growth. Apple has proved them wrong, but Apple has been an exception. Historically, size has been an enemy of fast growth. Eventually, the naysayers will be right, but this might not matter.

Everyone and his grandmother has heard of this thesis and it is already discounted by the market in some form. How else would you explain the fact that $AAPL is trading at 15 times P/E while it is growing its earnings at 50%. The market clearly anticipates slowdown in earnings and if there is a surprise, it is likely to be on the upside.

Should Apple Pay Dividends – Not Today

There have been many discussions lately about the money hoarding by the big U.S. tech companies. The common denominator is that $AAPL  and $GOOG should start paying dividends. At this point, this suggestion is ill-advised and doesn’t make any sense.

Apple’s current ROE is 41%, which means that it makes 41 cents for every $1 of its capital. Logic says that if Apple’s shareholders cannot find an investment with higher than 41% return, they should not want to get paid dividends. Apple is still using their capital wisely.

Expectations Going Forward

Over the past few quarters, it has become a tradition  for $AAPL to appreciate in front of its earnings report, reflecting general expectations for positive surprise. The price action after the report hasn’t been that inspiring as “buy the rumor, sell the news” effect has dominated. I don’t expect this quarter to be any different, but anything is possible.

Disclosure: At this point of time, I don’t have a position in $AAPL