To chase or not to chase? That is the question as Twitter’s stock (TWTR) makes its market debut Thursday. With IPO shares finally priced at $26 each, there are almost certainly frustrated investors out there who weren’t allocated what they believe was enough stock from underwriters – and others who were shut out of allocations at that initial price altogether. Those traders should help propel the stock sharply higher when it starts trading.
Even so, any traders or speculators out there looking for the kind of huge first-day “pop” in trading that was almost routine back in the glory days of the dotcom market might want to rein in their expectations for Twitter’s debut.
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A healthy “pop” these days is likely to be in the double digits; the average first-day rise for U.S. IPOs this year has been 17 percent, according to The Wall Street Journal. An extraordinarily sought-after stock might double or more in its first hours of trading. But anyone hoping that Twitter will soar to $70 or $80 by Friday is likely to end up disappointed.
In part, that’s because Twitter’s valuation is already extremely rich. As we discussed here earlier this week, the IPO has been carefully managed – heck, let’s call it stage-managed – by underwriters led by Goldman Sachs. The company’s shares were almost deliberately underpriced in the first stages of the deal, during the road show.
Only in the last few days, once buyers had been lured into expressing interest, did the company and its bankers toss that conservative approach to the wind, boosting the initial range of $17 to $20. They raised the range not to something like $20 to $22 (the traditional kind of move) but all the way to between $23 to $25. And then they priced the offering even higher, valuing the company at $14.2 billion.
At the $26 initial price, the deal wasn’t just sweetened but super-sweetened. After setting out to woo investors by suggesting shares would be priced at a discount to Facebook’s (FB) shares, on a price-to-sales basis, the $23 to $25 range put Twitter’s stock at 11.8 times estimated 2014 sales, a premium to Facebook’s price/sales ratio of 11.4 times.
Nonetheless, some investors still figure that Twitter shares will be worth $43.60 by the end of trading Thursday. If they are, it will be because of momentum, not valuation. In other words, people will be chasing Twitter higher.
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Which brings me back to my initial question: Is it ever OK for investors – real investors, I mean, and not speculators or short-term traders – to chase a stock as its price soars into the stratosphere?
Common sense and conventional wisdom says no way, no how. So does recent history, as the number-crunchers at Birinyi Associates remind us. Since 2011, Internet IPOs have produced an average loss of 8.6 percent in the six months following their debut, with 62 percent of them generating a loss to investors from the opening trade to the end of the initial six-month period. Only 41 percent of those stocks have beaten the S&P 500. Even if you drill down more narrowly and focus only on large social networking and mobile website companies – Facebook, LinkedIn (LNKD) and their ilk – the track record isn’t much better.
Of course, some investors will ignore that history. As one self-described recovering banker blogged Wednesday, this amounts to a kind of hubris: imagining that they know more than the insiders and the pros who were quite willing to sell at a particular price. Sitting across the table from underwriters and insiders, what should be running across your mind is, “My, what big eyes they have,” and “My, what large teeth they have.”
There’s only one reason to chase a stock or a market, and that’s because something has happened to alter the outlook for the company or for an asset class in a material way. A company has landed a big new contract, reported sharply higher earnings and raised its estimate of future profits. A drought hits America’s corn crop or Brazil’s coffee harvest. We get some really bad employment data, suggesting that Federal Reserve policymakers will keep plugging along with their QEInfinity.
In those circumstances, if you find yourself chasing a stock or other investment as its price climbs, you’re at least doing so based on logic: Something has changed to make it more appealing to own. That’s enough of a reason to make the undignified spectacle of scrambling to buy a stock a little easier to tolerate.
Even then, you need to be able to withstand the volatility that is likely to follow any big movement higher or lower. A 10 percent or 20 percent surge in any stock is going to leave analysts and institutions scrambling to reset their expectations, baffle market technicians and briefly unsettle established patterns.
Eventually, some kind of new equilibrium will be reached, but the process of getting there can feel like one of those amusement park rollercoasters – the scary ones that do big loops and leave you hanging upside down. If you have to chase a stock higher, pick one whose increase in value has been based on fundamentals and whose price gains have been slow and incremental. You’re less likely to wind up with heartburn.
When the only reasons that a stock is heading for the stratosphere is because a group of investors are playing catch-up or succumbing to irrational exuberance – or because the stock in question is a scarce resource (as Twitter shares are likely to be) – that’s a sign that you’d be chasing it for all the wrong reasons.
Here’s the reality check: Twitter at $26 a share isn’t a different company from Twitter at $17 to $20 a share. All that has changed is that underwriters managed to whip up enough excitement to charge a higher price. At the end of the day, the Twitter share you buy at $26 or higher is the same stock that underwriters first suggested selling for $17 to $20. To some eyes, that stock isn’t an asset that should command a premium price much less be one that’s worth chasing higher.
Whenever you’re tempted to succumb to momentum investing, stop and ask yourself why you didn’t already own it at a lower price. Has something material changed? If not, why are you even thinking of owning the same asset at a higher price?
If, as in the case of Twitter, the answer is that the stock wasn’t available to you, well, the decision gets tougher. Then you have to decide just how scarce and how valuable Twitter shares are and whether they’re likely to remain that way over a reasonable time frame.
There are some things that are so rare and precious that they really are worth chasing – the amber room of the Tsars springs to mind, or the treasure of the Templar knights, or even the Holy Grail. Twitter may not be one of them.
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