Soap Gets In Your Eyes

To paraphrase Alan Greenspan's Congressional testimony from a few years back, "You can't spot a financial bubble until you've got soap in your eyes." IPO markets are notoriously inefficient, and so it seems absurd to look at the current spate of IPOs as a measure of market health.

As an institutional analyst, I had lots of good customers who were portfolio managers at FIMR (Fidelity). I always learned something from their questions, which were rarely rote or predictable. I was wrapping up a presentation to one Fidelity's longest serving and most distinguished value fund managers, when we started talking about the IPO of the day (I forget the issue in question). The company's valuation was as absurd as those of the current Chinese social media networks and Russian search engine companies. The frenzy and the race to demand a share of the IPO from your favorite institutional salesperson was on.

I made a comment to the effect, "Well, I know this is a game you're not involved in!" The portfolio manager looked at me with some understanding and said, "Eapen, if someone standing on the street corner is handing out free Swiss candy that I can turn around and flip for a riskless profit, I should take it, right?" I was non-plussed, but it was an "Aha!" moment for me. This was early afternoon on the IPO day. I asked, "Have you flipped your allotment already?" He said, "Yes." It all made perfect sense. A totally inefficient market, under priced on the front-end from the company standpoint, and fuelled by P.T. Barnum psychology. A profit, is a profit though; the annualized rate of appreciation the Fidelity PM made on his stake was a nice bon-bon for his monthly portfolio performance.

On the flip side of the "New Tech" bubble are references to "value stocks," like Google and Microsoft. Value stocks in the Graham & Dodd parlance were selling below their fundamental, tangible asset values, with a "margin of safety." Railroads, for example, had huge assets in rolling stock which had an active secondary market, and which ultimately had scrap metal value in the worst of all cases; they had enormous real estate assets and rights-of-way. Those kinds of stocks with a margin of safety were real value stocks, where the company was selling well below its liquidation value. I confess to not knowing about Google's business or valuation, but it's not a Graham & Dodd value stock; it might be a "fallen angel," or "GARP," however.

Microsoft is another question altogether. Microsoft reminds me now of an AT&T type monopoly utility, just before the advent of wireless telephony. It may be a value stock, or it may be a value trap. The overpaying for Skype seems to be another knee jerk transaction by a management with a mediocre record of creating value. Perhaps it's different this time. Or, as the soulful Ronnie Milsap sang, Microsoft investors may be "Lookin' For Love in All the Wrong Places."