Emma’s Note: Emma Walsh here, managing editor of the Diary.
Regular readers know that stock investing isn’t our usual beat.
But we know that many of our readers like to invest. And we know that the media hype can make some investments seem almost irresistible.
But a recent high-profile event in the markets illustrated a very important lesson for investors… and we want to make sure our readers are aware of it.
Read on below to hear more from our colleague Jeff Brown on how to avoid falling victim to the hype… and how to safely unlock the biggest gains…
On September 27, 2016, I sent out an urgent alert to my subscribers…
I recommended purchasing shares in a little-known enterprise software company focused on hybrid cloud computing technology.
It was a Tuesday. And the initial public offering (IPO) was scheduled for that Friday, September 30, 2016.
There wasn’t much time. But it was a great investment opportunity. I remember practically pulling an all-nighter to get the research and analysis done in order to feel confident in the recommendation.
At the time, the company was tiny, with only $846 million in annual revenue in its current fiscal year and an enterprise value (EV) of just $2.2 billion at the time of the IPO. That was an EV/sales ratio of just 2.6 – for a super high-growth, high-margin software company. Crazy.
I knew the company well. And I saw that the underwriters – the investment banks – of the IPO were underpricing the deal. Their mistake was our opportunity.
At the time, I wrote:
I believe that with [this company’s] leading-edge technology, combined with the fact that it will be valued more like a software company, we have the opportunity for a massive gain.
We were able to build a position at $16 a share. 11 days later, we closed out the position at $32.01 – for a 100.1% gain.
One reader, Peggy G., wrote to me and said:
Hello Jeff Brown. Thank you for the urgent IPO alert – I made a bundle on it!
I was thrilled to hear that my readers were able to make a great return in only a few days.
2016 feels like a long time ago. I almost feel nostalgic for those days. The markets have changed dramatically since then, especially for technology IPOs. The chance for normal investors to gain access to shares in high-quality technology IPOs at or around the IPO offer price is pretty much gone.
But that doesn’t mean that there isn’t an appetite for quality research in this space. Here’s Peggy G. again…
Has [your publisher] ever considered offering an advisory service in IPOs? Especially the kind you can buy at IPO, or at least on the first day of open market, and sell quickly thereafter for a nice profit on the trade? If you ever decide to offer such a service, I would love to be in on the beta testing!
Sadly for Peggy and all retail investors, it is nearly impossible to get into a great IPO at a reasonable valuation. That is why I steer my subscribers away from overvalued IPOs. Investing in them is a surefire way to lose a lot of hard-earned money.
And we just saw the perfect example…
An Easy Way to Lose Money
On September 16, Snowflake (SNOW), another cloud software company, went public. It was the largest software IPO in history. Snowflake’s shares were priced at $120, putting the IPO valuation at an incredible $33 billion.
But that’s not the end of the story.
Snowflake’s share price opened at $245 a share, a bit more than double the $120 offer price.
Sadly, normal investors had no chance to invest anywhere between $120 and $245. There literally was no window to get in. Only institutions and very high-net-worth individuals were able to get allocations of shares in this exciting new cloud company.
As just one notable example, renowned investor Warren Buffett invested in Snowflake through Berkshire Hathaway – a big break from his usual investing habits. At the time, the offer being discussed was to sell 28 million shares in the $75–$85 range. But demand over the following days pushed up the price to $120.
On the first day of trading, the stock closed at $254 a share, resulting in a $71.4 billion valuation.
That’s incredible. And Berkshire Hathaway made about $800 million in a day as a result. At Snowflake’s high of $319, Buffett’s one-day winnings would have topped $1 billion.
Compare that to regular investors. Any investors who managed to get in at $245 were up barely 4% on the first day of trading. And if those “lucky” few who got in at $245 held to today… they’d be down roughly 8%.
And it gets even nuttier…
Valuation vs. Hype
The hype surrounding Snowflake was intense. It broke all-time records for software IPOs.
Leading up to September 16, we saw headlines like “Tech investors await IPO bonanza next week, highlighted by Snowflake”… “Why You Must Not Ignore This Tech IPO”… “Snowflake IPO Preview: The $35 Billion Bull Thesis”… and even “Snowflake Gives Investors a Rare Opportunity to Disrupt Amazon.”
It’s easy to see why lots of investors got caught up in the hype.
And that’s not to mention the many folks who reasoned that Snowflake has a great service. In fact, I agree on that point. I really like Snowflake’s technology. It is a bleeding-edge, cloud-computing software company.
But ultimately, it doesn’t matter what kind of hype a company is generating… or even how much I “like” a company.
A good company at a bad valuation is still a bad investment. And right now, Snowflake is a terrible investment.
Snowflake’s current fiscal-year sales forecast is about $403 million. That’s less than half the fiscal-year revenue of the company I recommended back in 2016. It also means that Snowflake traded at a whopping EV/sales ratio of 177. That’s a value equivalent to 177 years of revenue (not profit).
Compare that to the 2016 recommendation I made with an EV/sales of 2.6. That was cheap.
Some companies can justify an EV/sales ratio of 10, as long as they have the gross margins and growth rate to support it. But 177 is insane. Investing at these valuations will guarantee a material loss of an investor’s hard-earned capital.
If you take nothing else away from this essay, let it be this: Investors should be thoughtful whenever they decide to invest in a “hot” IPO. Let’s always understand the valuation and future growth prospects of a company.
Unfortunately, most IPOs are a racket. While investors like Buffett can make incredible returns on IPOs like Snowflake, normal investors have no shot at life-changing gains. And very often, they’re left “holding the bag.” It’s absolutely unfair.
That’s why I went on a search for something better… a way for regular folks to win at this rigged game.
Over five years ago, I began looking for a way to turn the tables on this situation… a way for normal investors to have a shot at venture capital-like gains.
And I’m happy to say I’ve found the answer to this dilemma.
A class of stocks I call “Penny IPOs” has the potential to rise hundreds of percent in just days… or even hours.
But unlike Snowflake, these Penny IPOs go public early, when they’re still cheap. In fact, some of these Penny IPOs go public at levels even cheaper than Amazon did in 1997… before it delivered gains of as much as 180,000% to average retail investors.
And because they go public while they’re small, they’re not on Wall Street’s radar yet. We can buy these companies before the insiders get in.
And that’s not even the most exciting part of this opportunity…
We’re now entering the “4X Window,” a period that is going to send these tiny stocks into overdrive. Serious tech investors absolutely need to know about this burgeoning trend.
If you want to get all the details on these Penny IPOs… and learn why they’re so unique… you can go right here to watch my recent presentation.
There, I explain the whole backstory on these stocks… why they still go public so early… and what the 4X Window is.
This presentation is only available for a few more days, so make sure you don’t miss out.
Editor, Early Stage Trader
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