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Welcome to session 16 of the Investing for Beginners podcast. In today’s session, we are going to discuss IPOs and why you shouldn’t invest in them. We are going to use the recent Snapchat stock  IPO as well as their latest earnings reports to help us understand why Snapchat stock is not a good investment at this time, or if it will ever be a good investment.

• Snapchat had a recent IPO, and since then the company has been under siege.
• Yesterday’s earnings report was dismal, included were a drop in revenue as well as customer interactions.
• Buying a stock is risky enough, do you need to incur more risk by investing in an IPO.
• Remember that the ones making money from an IPO are the players, pitchers, team officials.
• Having a checklist to go over when investing is critical
• The Margin of Safety is a must, with a focus on the safety part of it.

Without any extra preamble let’s jump into the podcast and see what Andrew and Dave are cooking up.

Andrew: Yeah, let’s talk about IPOs and the most recent one everyone is talking about, Snapchat, the dirty pick app. A lot of people that I know use it, and it is obviously a very popular among millennials. We’ve mentioned before on the show, and I think it was you, Dave, that how a big percentage of users on Robin Hood had bought Snapchat stock, so we’ve riffed about it and maybe degraded it a little bit just for fun as one of our whipping boys.

But I think it is a good opportunity to look specifically at the numbers and maybe let’s diagnose why it’s it’s tanking like it is. As of today the stocks is down to $18.05, and it’s started up around 27 or 28, and a lot of investors or so-called investors, people that think they are investors, people that bought Snapchat stock have already seen a significant loss, 33%. To make up a 33% loss you are going to have to make, I don’t have the specific numbers here in front of me, but I want to say it’s a 50% gain, or something close to that range.

It’s a tough hill to climb, and when you lose that much money the more money you lose, it’s a higher percentage that you have to earn in the future to make that up. To be an investor, especially a beginning investor and to have a loss like that not only mathematically a terrible proposition but the kind of things that it can do to your confidence as an investor. It’s something that can turn people off and just make them think let’s just forget this whole thing, and I don’t want anything to do with the stock market. And if anything is crippling and troubling for someone’s financial future is to forget or try to ignore the stock market completely.

Dave: Yeah exactly, that’s the scary thing about something that happens with an IPO or a newer company and going public with Snapchat. The analysts that were doing the analysis for the bank that was going to be putting up the money for the IPO recently they admitted that they made some errors in their financial analysis of the company, which should have adjusted what they thought the company should start selling the stock for when it went public. Instead, they left it exactly where it was, and it hurt the investors that got into it.

Like you said a lot of the millennials, the people that were using the app Robin Hood, the majority of those people were millennials and they are getting burned by this. People walk into something like this a little bit unaware, and I’m saying not saying I’m a guru by any stretch of the imagination. But I think that the thing to me that is most disappointing about this is that people were. I don’t want to say mislead, that is maybe not the right word, but they walked into something without knowing what they were walking into and if you read any of the reports from other analysts besides the bank that was putting up the money. They have a financial incentive for that company to do better on the IPO because then they make more money.

The other analysts were very, very skeptical of the company. Snapchat has been burning through money basically since its inception, and they haven’t figured out a way to make the company profitable. They haven’t figured out a monetization of what they are doing to make money. And that was a big concern when the company went public. How were they going to do this, how were they going to go from being private where they don’t have people like us to answer, and being able to do their own thing. And not having to worry so much about that other than their employees and their users. Now they have people investing money in it and some cases a lot of money. Not a $100 but hundreds of millions of dollars and so when something like this goes south that quickly it can be very disconcerting and the problem the company was having before it went public. These are all the same problems they were having six months ago, a year ago and they haven’t changed.

The concerns about the profitability of the company as well as the CEO, now this is not a denigration on the actual product itself, I don’t use Snapchat, but from what I’ve talked about from people that use it they love it. They think it is a great product and the love to use it. But Snapchat has not figured out how to make money from it yet, and that’s the biggest concern, and that’s what is killing the stock.

Even Andrew mentioned a moment ago that it is down 33% since it’s original IPO, it is down 20% on Wednesday and so on one day it went down 20%, to regain that 20% is a big hill to climb. To drop from $23 to $18 in one day is a big hill to climb, especially when the company is not profitable when it’s losing money.

Those are the things that Andrew and I have talked about many times many, many times. That is buyer beware when the company is losing money like that, burning through cash like that. That is a big, big no-no, think about in your personal life. If your spending more than you are taking in how long can you continue that on your own. That is what this company is doing, how long can they continue to find people that are willing to invest or banks to continue to loan them money to allow them to continue doing what they are doing. The focus of the company is very much on innovation and being creative and coming up with great products. I don’t think that anybody would disagree that they are capable of doing and have done a great job of that so far. But they have two really big hurdles to climb. One is the profitability, and the other is the competition from Facebook and Instagram, those are companies which are huge monsters in and of themselves, they were not going just to sit there and let Snapchat come in here and say Hey here we are guys, were going to do our thing. Don’t care what Facebook is going to do.

You knew that Facebook was going to fight back and they have, and it’s hurting Snapchat, and those are the things that are very concerning to me.

Andrew: I love the point of how you say the company is not making money and that really should be the number one discussion. And maybe for somebody listening who doesn’t understand why we feel so strongly about that it’s not some random opinion that Dave and I have, it’s not our pessimism towards the future, or it’s not our skepticism that Snapchat could eventually make a profit some day. Where not saying any of those things.

What we are saying is that when you have a stock or business, and it is not making money, that’s a failure of the number one goal of business. While yes, many of these businesses can turn it around. Very much more don’t and it’s not something that is an idea, it’s based on the history of what we’ve seen in the stock market before. If you look back at the history of the stock market, what are some of the things that you can use to learn lessons? We know that the stock market has crashed, the stock market has gone through these storms, these bear markets where there is just chaos, people freaking out, doubt, despair, and low profits and these sort of things. By the same token, there have also been very optimistic times.

The innovations that happened in the 1920s and the great years they had a high economy and high profits and a stock market that just went straight up. We’ve seen that in the 80s and 90s, I’m not a history buff but I know there are time periods where we have seen this happen and this is a cycle just like the weather. We have seen this continue as time goes on we continue to see these cycles and a big, big one was this idea that was going to be bubbles and when there are people just too excited about making money in the stock market.

They are going to forget about basics and fundamentals and principles and just logic. The company loses money, it’s not a good company, but people forget that, and they want to talk about growth. In the late 90s, they had the internet stocks, and there was a huge, huge portion of them that just didn’t make money. It was the majority of them that didn’t make money.

And people made fun of Warren Buffett because he didn’t buy any technology stocks at that time. We had an environment had a situation where companies would put a com at the end of their name, and their stock price would double or triple. They would issue an IPO and people were in such a craze that it didn’t matter didn’t make money, or it didn’t matter that the company was priced like a regular stable business that had been around for 100 years and that continued to make profits and create dividends for its shareholders.

These are just companies that were trendy, and people thought that what used to work in the stock market doesn’t work anymore. And this is a new world, and this is new technology, and it was true that the internet was changing the world and we had companies sprout out of nowhere and being based purely on being able to thrive on the internet and not be this traditional brick and mortar type of business.

But what ended up happening for almost all of these technology stocks where once the bubble popped. They all crashed to the ground, especially the ones that had negative earnings, many of them went bankrupt. There are very few companies left that were able to survive this phenomenon.

This was because of two things, first that the businesses weren’t that good, they were losing money. And number two, a large number of them were just outrageously priced and based on what the business was doing and how it was performing and how the stock market was perceiving it, and it was just night and day.

Completely ridiculous that investors would think the businesses would be worth that much. When we talk about Snapchat, and I have a featured tweet if you go on my feed @valuetrapblog. I would say that social media is the new tech bubble because it is true. Facebook started it, and yes, they have done well. They’ve been one of those exceptions to the rule where they’ve, I mean I still wouldn’t buy the stock because they are ridiculously overvalued, but they are growing at a very accelerated rate, and they have been able to monetize in a way that no other website has been able to do.

If you ever use Facebook nowadays, they are very clever in the way that they advertise. They even used this feature where they are trying to migrate people to Facebook video, in the past, there were a lot of videos embedded into Facebook like Vine was big. I don’t know if it something that Facebook is enforcing but or if it is naturally happening where more videos are being more Facebook videos instead of coming in from a third-party website.

So what Facebook has been doing, instead of having an ad at the beginning of a video they let the video run a little bit, so as people are scrolling down their timeline and they will see a video, and it will catch their attention. And they will watch it, and then Facebook will place an ad in that video that you can’t skip at all and then the video continues after that. So, they have been doing that, and they’ve been placing ads that you don’t necessarily notice that there-there, but they are, and it’s very aggressive. They’ve been able to increase earnings very quickly really.

We will see what happens in the future, chances are, I am not a psychic, but it’s just the way the stock market has gone for hundreds of years. If they stock overvalued or too expensive, eventually it’s not going to be able to keep up with the market’s demands.

Like we said last week it is the greater fool theory, people are paying more for the same stock, and somebody is going to be left holding the bag, and it is always the majority of the investing public, and they are the ones that get burned. This is something that we are very passionate about trying to limit people from falling into that trap because we care. There are good things and bad things in the market I think diving into the market and losing 33% of your money is a terrible proposition and I wouldn’t wish that on any beginner.

Dave: No, not at all. That is a scary place to be to start down that much. If you are just starting out and you’ve come across our podcast, or you’ve read some other information, and you think that this is a great way for you to start building some wealth, and it is.

If you buy into something like this that loses that much that quickly it would scare you and sour you. I was lucky I bought Microsoft for my first company. Admittedly when I bought it, I thought it was a boring, staid, old-school technology company, which I came to learn I was wrong about that.

Microsoft has done well for me, and I know that Andrew bought Microsoft for your first one and I am sure it has done really for you as well. But it doesn’t mean I am some genius when I bought it. I had been reading some stuff, and I had decided I wanted to buy my first stock. I went back and forth on what I should buy, I figured I should buy a company that I knew, and I knew a little something about, and I also thought I should buy something that wasn’t a big gamble, wasn’t a big risk.

That is one of the things that Andrew and I talk a lot about, and this is why we are so passionate about this subject. We are not trying to bash Snapchat by any stretch of the imagination but we what we are trying to do is help people understand that there’s always a mania that can go on with an IPO and there is always a mania about the hot new thing. We want people to be cautious when they’re trying to invest their money.

Think about the money you make you work hard for that, whatever it is you do, and it’s precious. And when you are going to invest for your future, buy a house someday, or send a kid to college or even maybe you to college.

Whatever it maybe, you worked hard for that money and to get excited about a company and put your hard earned savings into it and have 33% evaporate over a few month period because you walked into something unknowingly that to me is a disservice to the financial industry.

Our job should be to educate you before you make that purchase to make sure you understand what kind of risk you are taking when you do buy into it. Let’s make no qualms about it when you are investing you are taking a risk, there is always a risk when you are buying a public company. There are no absolute guarantees, regardless of how well Facebook recently.

Andrew was right about it Facebook, and they are an anomaly in the social media and marketing realm. You think about the big players we have Instagram and Facebook and Twitter, who has done very, very poorly and their IPO was very similar to Snapchat. It was huge, and people were going crazy for it, and it tanked, it’s done very mediocrely since just limping along, and there is all kind of debate on the financial sites about whether Twitter is going to survive.

The main reason is again it’s not profitable, not making any money. In the long-term when we invest we want to invest in a company that is making money because the only way they are going to pay us back is if they do well and they makes money. Let’s not kid ourselves when we’re investing in companies it is all about capitalism, and we are looking to make money. Yes, we want to buy companies that we think are good and are that moral, going to try to do the right thing for us, the country, and the world.

But we also have to remember that we want it to make money and if it’s not making money then why are we investing in it? Buying Twitter, Snapchat, those are challenges. You know Snapchat has a big hill to climb now, I was just reading something earlier today about them. The CEO in his first earnings conference call, every quarter they do earnings reports and the CEO, and other members of his team will come on and give statements and then be interviewed by other analysts that are assigned by the banks to cover these calls.

The CEO in his conference call yesterday said that he likened Facebook to Yahoo and he said he would compare his company to Google, so he’s saying that his company is going to be hugely successful and their more like Google, who has done great things and has become a verb, Googling. Whereas Yahoo is dying a horrible death and at one time they were the king, and now it’s like AOL, it’s dying.

So he is comparing Facebook to Yahoo which is dying, which is incredibly arrogant of him to say that. And that again is a concern when the CEO is making comments like that; it shows that maybe he doesn’t get it or is out of touch with what is going on with his company.

Andrew was talking about the growth of some of these internet companies and some of the companies like Facebook, that is another issue that Snapchat had, the two big issues besides some of the other things we have talked about. First, their revenue was down, which is a big thing, it means their sales were down. Number two, their user interactions were down, which means fewer people were using their product.

Andrew: The DAU, the daily average user.

Dave: Yep, that’s it exactly. That is one of the big things for example with Netflix. When people look at Netflix that is one of the big metrics that look fort. How many people are using Netflix because that is a huge indicator of the popularity or lack of popularity of their product? And when you look at Snapchat it is all about who is using it and how many people are using it. And if that number is down that’s a big red flag; this is another issue that Twitter was having, their interactions were down.

Facebook is the exact opposite. How many of us can’t get away from Facebook, I am not a big Facebook person myself, but my wife loves it, can’t get enough of it. How many people are like that? That’s kind of where we are coming from with all of this is when you buy a stock you need to be prepared and understand what you are investing in.

Now if you are buying your first company, and you’re only going to put $50 or $100, yes you worked hard for that money, but it’s not a huge loss. But let’s say you walked into this and it was the first thing you were going to buy and you dropped $10,000 on it without doing any homework to understand what it is you were buying, that would be a shame. That is such a huge loss, and that breaks my heart when I hear about that kind of stuff.

A hundred bucks, fifty bucks yes that is disappointing, but you can recover from that. That is a weekend dinner with your wife that you can recover from. But from a $10,000 investment and to lose $3300, that is a big loss. That is where Andrew and I are coming from with all of this.