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Happily Ignoring IPOs

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In the first Internet investing heyday of the late '90s, almost anyone with a business idea and a web site could create a company and hold an IPO in a few months. You could raise millions of dollars selling stock in a company even if it didn't have any revenue, or even customers. The motto was "get big fast". It was okay to burn through millions of investor dollars to build mindshare and get network effects, hoping that someday you'd get a profit, or at least revenue.

While some people claimed that the world of business and investing had changed, we all relearned the important lesson: companies that make money stay in business. Companies that don't make money don't last.

Facebook's IPO

Facebook had its public IPO in February 2012. It raised a hundred billion dollars, which made many of its early investors a lot of money. If you go by popular sentiment in parts of the press, you might think people were lining up to buy shares of Facebook in the hopes of also making a lot of money quickly.

That didn't happen.

In truth, if you ignored Facebook's stock altogether, good for you! You acted wisely. Ignoring IPOs is almost always the right choice.

Facebook may turn out to have been a great investment. In February 2022, people might look back and think that $38 or $40 or $42 would have been a bargain if we'd bought at that price and held onto the stock all those years. That may happen. (It's doubled in price since the IPO, at least as of February 2015. That's not bad, but you could have done better.)

What Will Happen to a Stock After the IPO?

Here's the problem: no one knows what will happen with Facebook. Worse, at the time of the IPO, no one had any history with the business as a public company to guide them. Facebook—indeed, any company offering its stock for the first time—can only provide prospective investors with so much information about its finances and history and future plans. You can make extrapolate based on what they say, but there are too many unknowns. All you can do is guess.

Some people will argue that the pent-up demand to own a piece of Facebook or any other popular company going IPO will undoubtedly drive up the price in the short term. This isn't research at all. It's speculation, driven by market timing and the desire to outsmart other investors by outthinking them. You need luck for this strategy to work, and only one person can be the smartest person in the market. The numbers aren't on your side.

Big institutional investors with lots of money to invest can make a few quick bucks from this IPO flipping. You probably don't have the money to get in on this yourself, unfortunately. You'll end up being the one giving the big guys your own money.

If Facebook is a good company and a company built to persist in its greatness, its financial numbers will reflect that in the next five and ten years. At that point, a careful value investor can look at the free cash it generates and see that number grow at a predictable rate. You'll see how it reinvests that money in its business and how it plans to make more money every year. You'll have data to review and analyze.

You'll be able to tell a story about the company and see if that story makes sense.

What You Don't Know about the Business Behind an IPO

If you're looking at the next big IPO, you can't tell that kind of story. You don't know enough. You could guess, but when there are so many other great companies, why not look for other opportunities—less risky opportunities, because they have concrete facts and figures?

Maybe Facebook will turn an initial investment of $40 into $400 or $4000 in the next ten years. Maybe it'll turn that investment into $4. It's too difficult to predict, so why even try? You don't have to, though. You can put that $40 in something much safer with an 80% chance of success.

It's okay to ignore IPOs. Let the speculators have their fun. You don't have to play that game; a boring but safe investment such as an S&P 500 index fund has more predictable results over time (and will never go bankrupt like some of the IPO darlings of the dot com bust).

Boring Businesses (can) Make Great Investments

High-tech IPOs are exciting. Lots of people feel a connection to a Twitter, a Zynga, or a Facebook, and they want to own a piece of the company that's building all that buzz. There's nothing wrong with that, but make sure you're not overlooking a boring business selling lumber or health equipment or insurance—especially if that boring business has real customers, growing free cash, and a solid plan to continue to make more money year after year.