Wednesday, March 26, 2014

Here we go again - more junk investing

After the implosion of Zynga (the makers of Farmville) you'd think people would be a little gun-shy about investing in the "latest and greatest" gaming company, particularly one that makes cell phone games.

Games have a short shelf-life.   Stocks have a long one.   Investing, as the name implies, is not a ten-minute deal, but a ten-year process.   And flash-in-the-pan fads and trends are hardly worth investing in, unless you can get your money out right away, and walk away.   No one wants to be left with an inventory of hula-hoops, once the fad has died down.

And if you go into the stores these days, you can see that the "Angry Birds" merchandise is marked-down heavily.  What was once the cell phone game that "everyone" was playing is now hardly even thought of.   I am sure some people who were fiends on it a year ago will claim to have never heard of it, now.

Again, and I will say this slowly for the particularly dumb out there - a modern IPO has only one purpose, and that is to enrich the founders of the company at the expense of the shareholders.

Actually, perhaps this has always been the case.

A friend of mine recently gave me a stack of old antique automobile magazines, and it is interesting to read about the early days of the automobile.   The number of companies that formed and went bankrupt is staggering.   The car was the hot technology of the turn-of-the-century, and many folks were hoping to "get in on the ground floor" of the next hot company.   But for every company that made it, ten went bankrupt.   Even some of the major players, like General Motors, nearly went bankrupt after initial success.

And prior to that, in the late 1800's in post-Civil-War America, the big new technology was Railroads - with dozens of companies forming and selling stock and building rail lines and going bust.   And again, for every one company that made it, ten went belly-up.

And yes, even back then, there were con artists and shysters who formed companies with no intention of actually making money, but instead, just selling stock.  And there is a thin line between "legitimate businessman" and "shyster" in the stock business.   For the consumer-investor, there isn't much of a difference - either way, you lose your shirt.

Say you invested with Bernie Madoff.   You lost your money.  He is a crook and he went to jail.   But suppose you invested in one of these "dot com" technology stocks that went belly-up, or whose stock value plummets to 1/4 of its IPO price (which you foolishly paid)?   Is there any difference, really?  You still lost a lot of money.

And the "legitimate" company pays its founders huge salaries from the money raised by selling stock.   And the founders sell their shares on the open market, based on the hype of the IPO and make millions more.   They walk away from the smoking ruins of their dot-com company (or auto company or railroad) with millions in their pocket, while the shareholders have nothing.

The founder of Groupon, for example, was laughing his ass off as he wrote his humorous resignation letter.   And why not?  Even with the company imploding around him, he still made a ton of money, leaving shareholders, directors, officers, and employees to clean up the mess.   It wasn't his fault, after all, that thousands of idiots thought that a coupon-company was "the next big thing!" - was it?

And you realize what an idiot Bernie Madoff really was, as there are legitimate ways to make a ton of money on Wall Street, while still gouging the shareholders - and avoid all that nasty jail time.

Like I said, it is a game as old as the hills.   And you don't have to lie or commit a crime to play it.   You go on a "roadshow" and hype the value of your company.   You actually PAY people to say nice things about your stock.  You generate a lot of hype that the "little guy" investor buys into, and then you sell your stock in an IPO.   Never mind that the company is dependent on Facebook for all its profits and only has one product (as with Zynga) or that it has a "technology" that is really more of a non-protectable business plan that is readily copied (Groupon) or has a high-overhead, high-risk business that has a finite growth curve (ZipCar).  You just need to get Joe Public, who gets all his information from CNN Money, to throw a few hundred dollars at you, hoping they bought "the next big thing".   And if you can get a few million Joe Publics to do this, you can make an awful lot of money.

What got me thinking about this was reading about the Briggs-Detroiter automobile, a company that went bankrupt twice in six years, and sold a few thousand automobiles, of which only a handful remain.   The company went to great lengths to advertise its cars, spending a ton of money promoting what was, in essence, a very mediocre car.   Like most small manufacturers of the day, they bought their parts, including engines, from a number of sources, and then merely assembled the cars.  The results were predictable - a car that tended to overheat (no fan, no water pump) and was hard to find parts and service for, after the sale.

But they managed to sell stock - lots of it - and also sell dealerships.   And the principals of the firm made some money, before it went out of business, twice.

Fast-forward 50 years, and Preston Tucker is trying the same thing.   Yea, I know, you saw the movie and read the books, and you think that Tucker was "ahead of his time" and got a "raw deal" because the "big companies" forced him out of business.   But the reality of it was, his kooky car (which was enormous) was expensive to build, he was under-capitalized, and his chief finance officer had been convicted for (wait for it) stock fraud.

Tucker made money by selling dealerships and also by selling prospective customers parts of the cars he promised to build.   Many people put down deposits on cars and bought accessories like radios, and never saw their money again.   That he managed to build 50 or so of the cars is amazing at all.   That he had serious intentions of building a real car company, is, in my mind, up for debate.  

So, today, the latest cell-phone game company goes public - and the IPO price tanks right out of the chute.   Maybe people are waking up and realizing that just because something is popular doesn't mean it is also profitable or a good investment.   Maybe, but I doubt it.

It really doesn't take a lot of money to develop a cell-phone game.  Many are created by individual people, not huge corporations.  You don't need millions of dollars to develop "the next big game!" but rather, you need an outlet on the market to sell your stock.

Angel investors will pump money into a small company, hoping to make back their investment down the road when it goes public.   Those Angel investors don't pay the retail share price you and I would pay, to invest in the next "flappy birdies" or whatever.   They hope to pump up the company, do an IPO, create a marketable stock vehicle that the small investor will bite on, and then then sell out, doubling, tripling, or quadrupling their money (if not more).

You can play their game (literally) if you like, but when you buy that stock, you are not enriching yourself, just other people.

"But wait!" you say, "Suppose I miss out on the next big thing?  Suppose this new stock is going to be like Facebook and double in value?"

Well, that is the risk you take.  But bear in mind that for every ten companies that form in a particular field, maybe one is successful, and picking that one is hard to do.   And while Facebook has gone up in price, with a P/E ratio of over 100 (and no dividends on the horizon) the jury is still out on that.   You might make money trading the stock by buying it low and selling high.   But in terms of the stock having any real inherent value, it really hasn't happened yet.  Facebook is profitable, but still not profitable enough to justify the share price.   It is still trading at five times what a reasonable P/E ratio should be.  What magic makes it worth that much money?   And will it be around for the long haul?   Those are the questions to ask - and the Internet is littered with the carcasses companies that once seemed like long-term institutions, such as AOL.

People love the hype, it seems.  Whether it is Bitcoin, gold, dot-com stocks, or whatever.  Folks will invest in whatever is in front of them, or is in the headlines.   Not many look at the overall picture, the P/E ratios, the profitability of the company or whether it pays dividends.    For most folks, investing is akin to gambling - placing a bet and then hoping they win.

You might as well buy lottery tickets.