Bucks: Investing Should Be Dull

Carl Richards

Carl Richards is a certified financial planner in Park City, Utah. His sketches are archived here on the Bucks blog and on his personal Web site, BehaviorGap.com.

The last few weeks, we’ve seen multiple headlines about initial public offerings. Chatter around LinkedIn, Groupon, Pandora and even Facebook has made people excited about the potential of getting in at the beginning of what might be the next Google.

At the same time there’s been debate about whether we’re in another tech bubble. But it seems to me that everyone is skipping over the biggest question that tripped us up the last time I.P.O.’s were on everybody’s mind: what’s the actual value of the investment?

Let’s be clear from the beginning: real investing is about understanding the value of your investment. And frankly, sorting that out is about as much fun as watching grass grow.

Doing that work is not sexy, and it doesn’t generate big headlines. It’s much more fun to stand around at the neighborhood barbeque and talk about what everyone else is talking about, which happens to be I.P.O.’s right now.

But they can be tricky. Much of what helps you determine the value of an investment is history. And while every company has to file a report with the Securities and Exchange Commission before going public, wading through that report can be time consuming.

I often joke that the only way to get people to read the reports that companies produce is to print them and stick them in envelopes marked “Top Secret.” But instead of taking the time to read the report, people often jump on an I.P.O. because everyone else is doing it.

But come on now. Really? We used that excuse as children. If you end up buying any investment, let alone an I.P.O., just because your neighbor or friend happens to, you’re assuming that at some point you’ll find a bigger fool who also hasn’t done the math yet.

Failing to do the math trips up even the most enthusiastic investor. Just look at what happened to Pandora last week. Now, Pandora may ultimately prove to be a great investment, but here are just a few things that may have contributed to Pandora’s not so positive I.P.O. results:

• Pandora loses money on every transaction
• Pandora has no assurance that it can negotiate better terms when its current music royalties agreement expires in 2015
• Pandora’s revenue growth is slowing

Understanding how issues like these affect the value of your potential investment is critical. But we have a bad habit of pretending that we’re investing when in reality we’re speculating. Remember: investing is about value, while speculating is about price. Pandora did come out strong price-wise, but by the second day of trading, its stock price had dropped below the initial public offering price.

While Pandora is just the most recent example of what can happen if you choose to skip the details, it won’t be the last, nor is the risk limited to I.P.O.’s.

So are you prepared to gamble on whether someone will be a bigger fool after you and buy the investment you didn’t check out carefully? It’s much better to be bored than it is to be broke. The next time you feel the urge to invest, think long and hard, and ask yourself if the math adds up.

Article source: http://feeds.nytimes.com/click.phdo?i=d9e25ca13430ab0aee0c6d7385cfa500