When Value Buying Can Bite You in the Ass

Ten years ago, I was given the option to buy shares in an IPO for a small company called Google. You may have heard of it.  I looked at the financials and thought, “Jeez, this thing is overpriced.” So I ignored it.  The IPO price for early buyers was $60, I believe.  It currently sits at $1200 per share.  1900% increase.  Drats.

So here is one of the rare examples of when value buying ends up having you lose out in the long term.  First off, I think Google is worth around $650 a share right now.  I know I know.  That’s almost 50% lower than it sells for today…but it does sell for a premium.

But in 2004, Google had $3Billion in sales and last year it had $60Billion in sales.  So clearly they are a growth machine.  They have done a great job meeting expectations and leading the industry in ads and it prints money.  Who would have guessed that back then?  Not many, I would presume.

So do I beat myself up over this?  Yes and no.  Of course I wish I had done this, so I am upset about that, but if I had invested in Google back in 2004 based on what I saw, then I would have lost TONS more money on other IPOs now and in the future hoping for the same result and would have probably given back all of the Google gains over time.

Having a plan and sticking to it…assess your work over years and years and many investments, not the short term and a few investments.  Warren Buffett and Ben Graham and all of the investing greats didn’t beat the market each year…in fact, when years were good for the stock market, they tended to lag.  But they stick to their system and when times are bad, they tend to fair pretty well.

Short Term News Doesn’t Mean Long Term Value

When discussing the current stock market valuation, so many people tell me that since current earnings are putting the market at 15 times earnings, I am off my rocker for thinking it’s overpriced.  What people always forget is that the current profit margin as a % of GDP is at 11%, which is almost double the historical average.  Of course, everyone wants to extrapolate that out, but when looking at profit margin levels in the last 10 years, this 11% rate is even an anomaly.

So I ask this question: Back in 2008, the earnings on the S&P 500 got as low as $13 per share, I believe.  If you extrapolate out a 15X earnings on that, historically, it said the S&P 500 should have been at 195. Instead it bottomed at 666 or so.  So was the 666 level really worth 3.5 times more than the market should have been selling at? Of course not, and no one who I ask that question to says it was. Their response is some variation of “Well, that was an extreme one time situation.”  Why can’t the same extreme one time situation occur on the upside too!?!?!

Every other Friday, I teach a class at my old high school where I teach investments.  One of the analogies I always make is that if you were always a C student but suddenly, you got an A on a test because the teacher let you use an open book, are you going to apply to colleges and say you are a straight A, 4.0, student?  Of course not!

If you are a solid 4.0 student and all of a sudden you forgot, from some fluke occurrence, that you had a test today, and upon taking it, you earned an F, is your high school going to kick you out for poor grades?!?! Of course not.  Yes yes, one test may be too short of an example, so make it 1 quarter of grades…1 semester…1 year.  Whatever.  The bottom line is that if your fundamental study habits haven’t changed, why would your outlook change drastically?

There are good years and bad years in everything in life.  This is why we can’t extrapolate one good year to infinity and beyond and we can’t extrapolate one bad year to infinity and beyond. You have to look at fundamentals of why things are the way they are. If there is a shift in some sort of supply or demand, then I can understand that.

But that’s not the case here. In fact, the thing driving profits is low interest because of massive Fed spending.  We can all agree that that will not occur in perpetuity.  Well, we don’t know that for sure, but every time it does happen, it leads to bad economic outcomes which would then, in turn, drive stocks down.

Please don’t think short sided when things are GOOD or BAD.

WhatsApp – How Facebook isn’t spending as much as you think

I really dislike the idea of writing a blog post on WhatsApp because it has, by far, been the biggest news of the last week, I think.  WhatsApp has VERY SMALL revenue but they can charge their users $1 per year after the first year of free use, so with the 450MM users they have now, that’s $450MM per year in revenue. Big woop.

But of the $16Billion initial acquisition price, $12Billion of that was being done with Facebook stock.  So what you may ask?  Well, it matters big time and it tells me that even Facebook execs think their stock is overvalued.

Think about it…if you feel your stock is undervalued, you will never ever give that stock away to make acquisitions.  You would use cash because you feel like your stock will eventually go much higher.  On the flip side, if you think your stock is OVERVALUED, you will want to buy as much as you can with that stock because you feel the stock will go down in price, so you really aren’t paying as much.

To break it down further.  Let’s say, in a wonderful world, God came down and told you that your stock is going to be worth $20 per share in 1 week because everyone will realize how great your company is…But it is currently selling for $10 per share…would you EVER buy $10 worth of stuff with that $10 share?  No! God just told it was worth $20 per share in a week, so you wouldn’t be paying $10, you would be paying $20 since the share will be $20 in one week (yes, there are time value considerations here, but let’s not overcomplicate it).

Again, on the flip side, let’s say your stock is selling for $50 per share, but God said “Next week, your shares will be selling at $20.”  So anyone selling you anything for $50, you will try like hell to get them to take your shares because, really, you are only spending $20 in next week’s dollars to buy that stuff.

I hope it makes sense because it is a very telling sign when people are making acquisitions with shares.  It shows either a lack of liquidity or concern over stock price, or both.

So let’s say that Facebook, who is selling at over 100 times earnings, is actually worth 1/3rd of its current stock price after you account for growth in revenue and earnings.  Revenue and earnings increase nicely over the next year or two and they are able to justify the high valuation and sell at a reasonable multiple.  If the shares were to drop to the $20 mark, which could very well happen, their $12Billion in stock that they gave up is actually only $4Billion.  Add to that the $4Billion in cash and you have a total acquisition of $8Billion instead of $16Billion.  Not a bad way to make acquisitions when everyone is so high on your stock.  The company acquired believes they are getting shares in an awesome company that is high flying, while the CFO of Facebook knows that they are just giving away overpriced stock to fund expansion.