Things are very wrong in wonderland again.
Back in 1999, you could have literally thrown a dart at your daily newspaper, purchased the stock your dart landed on, and have picked a winner. Everyone had their two cents about the next stock you needed to buy, and the majority of the time, the reasoning behind the purchase was nothing more than "everyone else is doing it."
Fast-forwarding to this week and why you should worry: Apparently, Seattle taxicab drivers are full of hot tips again, and it should come as no surprise that social media and Internet-based businesses appear at the top of the list. I call it the "taxicab indicator," and it signifies another startling disconnect between actual results and emotional investing reminiscent of what we saw 10 years ago.
Run away ... run away!
Take for example the quality of recent IPOs in the social media arena. Renren (NYSE: RENN ) , Youku.com (NYSE: YOKU ) , and even more recently LinkedIn (NYSE: LNKD ) have shown us that the terrible twos don't refer to a social media stock's performance in the second year, but rather its second day! Following Pandora Media's (NYSE: P ) IPO yesterday and a close that was 9% above the company's offering price, I'm left wondering if we aren't going to see the same malaise set in with the Internet radio company that we've seen in other recent IPOs.
Why can't these companies keep their momentum up beyond their initial trading day? Probably because of two things your taxicab driver won't be able to teach you: First, earnings still matter, and second, these razor-thin offerings eventually meet with a massive share glut at the end of their lock-up periods.
Don't believe me? Take a look at these staggering figures:
Price/Operating Cash Flow
Source: Yahoo Finance. NM = not meaningful due to negative book value or operating cash flow. *Pandora's price/book does not reflect book value changes resulting from IPO.
Pandora has been around for 10 years and isn't yet profitable, and Renren and LinkedIn trade at stratospheric valuations relative to their operating cash flow. Since closing on their respective first days of trading, Renren, LinkedIn, and Youku are down 58%, 21%, and 19%, respectively.
An inside job
Also consider that many of these recent IPOs have been propelled higher by bringing only a small sliver of their eventual outstanding shares to market. A small float of shares allows for day traders to rule the roost and potentially to inflict irrational prices on an already emotional sector. Then later, once lock-up periods expire, inside investors often release a flood of shares into the market. Shareholders of Molycorp (NYSE: MCP ) , Tesla Motors (Nasdaq: TSLA ) and Motricity (Nasdaq: MOTR ) will attest to this.
Molycorp insiders have sold more than 18 million shares of stock since February, and according to a filing last week, their intentions are to sell up to an additional 11.5 million shares -- yikes! Motricity also fell victim, with insiders posting some substantial share sales following the expiration of the lock-up period. Sometimes, just the threat of selling is enough to cause pain; Tesla Motors dropped 15% the day its lock-up expired despite very few shares being sold.
Long story short: Earnings still matter. If you continue to listen to the latest hot tips or follow the herd without doing your homework, you're going to wind up as a sheep who's been fleeced. Nothing beats a good old-fashioned fairly valued stock, and right now, nothing on the IPO front is giving us that. With Facebook readying for a possible IPO in the next few months and evidence piling up that these IPOs are coming up limp after day one, do you really want to take the chance on any upcoming IPOs?
Do you have the gall to buy into any recent IPOs? Share your thoughts in the comments section below.