“It’s kind of like gambling,” said Hood, a 44-year-old telecom marketing executive in Birmingham, Ala. By mid-June, the shares had dipped to $60 per share, underscoring the importance of seizing the moment and moving quickly when tech IPOs hit the market.
As the stock market rounds up a long list of anticipated IPOs — including coupon provider Groupon, gamemaker Zynga and social-networking giant Facebook — it’s undoubtedly tempting to follow Hood’s lead. The market for these stocks is hot. They seem poised for tremendous growth. With many retirement portfolios still reeling from the financial crisis, it may not seem like a bad way to make up some lost ground.
But there is a fine print on that temptation, say finance professionals and advisers, and it goes something like this: Unless you have the nerve to make a quick, lucky gamble as Hood did, IPOs of high-growth Internet stocks are likely to be such a rotten investment that you’re better off parking your money in something old and boring, such as a Coca-Cola or a General Electric.
Jeremy Siegel, a finance professor at the Wharton School of the University of Pennsylvania and author of “Stocks for the Long Run,” has a term for this oft-neglected irony of high-growth investing. He calls it “the growth trap.”
“The growth trap is the belief by investors that they should buy the companies that have the fastest earnings growth,” Siegel said. “The trap is they don’t pay enough attention to the price at which they’re paying for this growth.”
It’s akin to buying a house in a stable neighborhood where the price accurately reflects both the upside and downside risk. Say you pay $100,000 in hopes of having it appreciate $50,000 once demand peaks. If all goes according to plan, you make 50 percent on your investment. On other other hand, if it’s a hot, up-and-coming neighborhood where the speculators have already bid up values, you might have to pay $200,000. You can still profit if your $50,000 bet pans out, but the return on your investment is now 25 percent.
Investors make this mistake all the time, Siegel said. “The historical evidence is very overwhelming that investors overpay for growth,” he said, pointing to shares of computer maker IBM and oil giant Exxon Mobil as an example.
IBM was the Facebook of its time in 1950. The computing revolution was imminent, and its shares were poised for much faster growth than Standard Oil of New Jersey, Exxon’s predecessor. Had you invested $1,000 in IBM in 1950, you would now find your investment worth 33 percent less than if you were cashing out Exxon Mobil shares, Siegel said. As far as earnings per share, investors in Jersey Standard finished almost three-quarters of a percentage point ahead.