Archive for May, 2006

IPOs are Lousy Investments

May 31, 2006


I found one of the best definitions of IPOs in this SmartMoney column: the author says that IPO stands for “Its Probably Overpriced” rather than “Initial Public Offering”. The trouble with IPOs is that they are lousy investments. I am now reading Contrarian Investment Strategies by David Dremen and he talks about a study (by Prof. J. Ritter and Tim Loughran) of IPO returns:

The study followed the returns of 4,773 IPOs traded on the New York Stock Exchange, the AMEX and Nasdaq between 1970 and 1990. The average return for IPOs was 3% annually compared to 11.3% for the S&P 500.

But, there is more bad news:

The median return for these almost 5,000 initial offerings was down 39%. That’s right. If you couldn’t get that handful of red-hot IPOs that doubled or even tripled on the first trade – and nobody but the largest money managers, mutual funds, or other major investors could – then you’d lose a good chunk of your original investment.

Tim Hortons (TSX: THI), which went IPO with much fanfare just a few months back, is now trading at $29 after changing hands between $33 and $36 on its opening day of trading. The VoIP provider Vonage (NYSE: VG) went public last week at an offer price of $17. The stock has been in a free fall ever since and closed trading today at $12. Vonage, which operates in a brutally competitive market also managed to alienate its customers by offering them shares before the IPO only to watch it plummet after its debut. Overpriced is a fair description of these investments.

More Reasons to Love Dividends?

May 30, 2006


While I love dividend-growth investing and follow the strategy in our retirement accounts, I prefer non-dividend payers in our taxable accounts (discussed in an earlier post). The main reason behind the idea is a preference for businesses that can reinvest earnings and earn a better return than is possible on my own. A secondary reason is to avoid losing a portion of dividends to taxes every year.

Mark Hulbert writes in The New York Times that new studies show that lower dividend payout ratios were associated with lower earnings growth going forward. The study’s authors point out that management does a poor job, on average, of investing retained earnings. They also point out that managements hate to cut existing dividends and are thus unlikely to increase them unless they are confident of future prospects.

As the column point out, the study is a reminder that if a business decides not to pay a portion of its profits in dividends, investors should keep a close eye on the company to see if it is able to achieve a high rate of return on reinvested profits.

The Smartest Guys in the Room

May 29, 2006


I watched the documentary on Enron over the weekend and a few months back, I had read the book on which it is based. Of all the corporate scandals, Enron is called the corporate crime of the century with some justification. As Bethany McLean, co-author of the book notes (and who originally asked a simple question – How exactly does Enron make money? – in an article in Fortune magazine), it is also a story not just of numbers or complicated accounting but a tale of hubris, greed, ambition, pride and arrogance that has all the hallmarks of a Greek tragedy.

I liked the documentary better than the book though many parts of the Enron saga like its disastrous foray into emerging markets are omitted. The documentary keeps a tight focus on the three architects of Enron’s swift downfall: Ken Lay, Jeff Skilling and Andy Fastow. Ken Lay was the visionary who had founded Enron and lobbied for the deregulation of the natural gas markets and Jeff Skilling was the man with the big idea that transformed Enron from a sleepy utility to an energy trader. The rest of the character cast is made of the “guys with spikes”, individuals with something extreme about them. The black sheep of the group was Andy Fastow, the young CFO who cooked the books hiding Enron’s massive debt in off-balance sheet arrangements.

The one key lesson from the Enron story is to trust no one, not the executives who encouraged their employees and investors to invest in their company while simultaneously selling their stake, not the analysts who were in bed with Enron to land investment banking deals, not the lawyers and accountants who rubber stamped the company’s financials and definitely not the bankers who knew helped Enron arrange the deals for guaranteed profits, when it comes to managing your money.

Last week a jury in Houston convicted Ken Lay and Jeff Skilling on various charges of conspiracy and fraud. I think the guilty verdicts were richly deserved when you watch rank-and-file employees losing their life savings while senior executives are quietly selling stock:

At one time things were really rosy for us. We all had some really nice looking 401(k)’s and pensions and then it peaked and then it just started going down and it went lower and lower and lower. At the peak I had about $348,000 and I sold it all for $1200. That was what I got for it when it was done.

– Al Kaseweter, a Portland General Electric Company (a utility acquired by Enron) Lineman

When you contrast this with Ken Lay, who sold about $300 million worth of stock and Jeff Skilling who cashed in about $200 million and other insiders who sold hundreds of millions of Enron stock, it makes your blood boil. If you haven’t seen the movie, I highly recommend renting it.