The Intelligent Investor_ The Definitive Book on Value Investing - Benjamin Graham [66]
More important, buying IPOs is a bad idea because it flagrantly violates one of Graham’s most fundamental rules: No matter how many other people want to buy a stock, you should buy only if the stock is a cheap way to own a desirable business. At the peak price on day one, investors were valuing VA Linux’s shares at a total of $12.7 billion. What was the company’s business worth? Less than five years old, VA Linux had sold a cumulative total of $44 million worth of its software and services—but had lost $25 million in the process. In its most recent fiscal quarter, VA Linux had generated $15 million in sales but had lost $10 million on them. This business, then, was losing almost 70 cents on every dollar it took in. VA Linux’s accumulated deficit (the amount by which its total expenses had exceeded its income) was $30 million.
If VA Linux were a private company owned by the guy who lives next door, and he leaned over the picket fence and asked you how much you would pay to take his struggling little business off his hands, would you answer, “Oh, $12.7 billion sounds about right to me”? Or would you, instead, smile politely, turn back to your barbecue grill, and wonder what on earth your neighbor had been smoking? Relying exclusively on our own judgment, none of us would be caught dead agreeing to pay nearly $13 billion for a money-loser that was already $30 million in the hole.
But when we’re in public instead of in private, when valuation suddenly becomes a popularity contest, the price of a stock seems more important than the value of the business it represents. As long as someone else will pay even more than you did for a stock, why does it matter what the business is worth?
This chart shows why it matters.
FIGURE 6-2
The Legend of VA Linux
After going up like a bottle rocket on that first day of trading, VA Linux came down like a buttered brick. By December 9, 2002, three years to the day after the stock was at $239.50, VA Linux closed at $1.19 per share.
Weighing the evidence objectively, the intelligent investor should conclude that IPO does not stand only for “initial public offering.” More accurately, it is also shorthand for:
It’s Probably Overpriced,
Imaginary Profits Only,
Insiders’ Private Opportunity, or
Idiotic, Preposterous, and Outrageous.
Chapter 7
Portfolio Policy for the Enterprising Investor: The Positive Side
The enterprising investor, by definition, will devote a fair amount of his attention and efforts toward obtaining a better than run-of-the-mill investment result. In our discussion of general investment policy we have made some suggestions regarding bond investments that are addressed chiefly to the enterprising investor. He might be interested in special opportunities of the following kinds:
Tax-free New Housing Authority bonds effectively guaranteed by the United States government.
Taxable but high-yielding New Community bonds, also guaranteed by the United States government.
Tax-free industrial bonds issued by municipalities, but serviced by lease payments made by strong corporations.
References have been made to these unusual types of bond issues in Chapter 4.*
At the other end of the spectrum there may be lower-quality bonds obtainable at such low prices as to constitute true bargain opportunities. But these would belong in the “special situation” area, where no true distinction exists between bonds and common stocks.†
Operations in Common Stocks
The activities specially characteristic of the enterprising investor in the common-stock field may be classified under four heads:
Buying in low markets and selling in high markets
Buying carefully chosen “growth stocks”
Buying bargain issues of various types