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Lessons from Warren Buffett - XLIV - Views on News from Equitymaster
 
 
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  • Jul 4, 2008

    Lessons from Warren Buffett - XLIV

    In the previous article based on the master's letter for the year 2000, we heard him talk about how investors, in their irrational exuberance, tend to gravitate more and more towards speculation rather than investment. Let us go further down the same letter and see what other investment wisdom he has to offer.

    IPO - It's Probably Overpriced
    If it is out there in the corporate world, it has to be in the master's annual letters. Over the years, Mr. Warren Buffett has done an excellent job of giving his own unique perspective of the happenings in the business world. Whatever be the flavour of the season, you can rest assured that it will be covered in the master's letters. Since the letter for the year 2000 was preceded by the famous 'dotcom bubble' and the flurry of IPOs associated with it, the master has spent a fair deal of time in trying to give his opinion on the same. And as with other gems from his larder of wisdom, strict adherence here too could do investors a world of good.

    On IPOs, the master goes on to say that while he has no issues with the ones that create wealth for shareholders, unfortunately that was not the case with quite a few of them that hit the markets during the dotcom boom. Unlike trading in the stock market, IPOs usually result in transfer of wealth and that too on a massive scale from the ignorant shareholders to greedy promoters. The master feels so because taking advantage of the good sentiments prevailing in the markets, a lot of owners put their company on the blocks not only at expensive valuations that leave little upside for shareholders but most of these companies end up destroying shareholder wealth.

    Hence, while investing in IPOs, two things need to be closely tracked. One, the issue is not priced at exorbitant valuation and second, the company under consideration does have a good track record of creating shareholder wealth over a sustained period of time. Thus, if an IPO is only trying to sell you promises and nothing else, chances are that you are playing a small role in making the promoter, Mr. Money Bags.

    Master's golden words
    Let us hear in the master's own words his take on the issue. He says, "We readily acknowledge that there has been a huge amount of true value created in the past decade by new or young businesses, and that there is much more to come. But value is destroyed, not created, by any business that loses money over its lifetime, no matter how high its interim valuation may get."

    He further adds, "What actually occurs in these cases is wealth transfer, often on a massive scale. By shamelessly merchandising birdless bushes, promoters have in recent years moved billions of dollars from the pockets of the public to their own purses (and to those of their friends and associates). The fact is that a bubble market has allowed the creation of bubble companies, entities designed more with an eye to making money off investors rather than for them. Too often, an IPO, not profits, was the primary goal of a company's promoters. At bottom, the 'business model' for these companies has been the old-fashioned chain letter, for which many fee-hungry investment bankers acted as eager postmen."

    To conclude, the master says, "But a pin lies in wait for every bubble. And when the two eventually meet, a new wave of investors learns some very old lessons: First, many in Wall Street - a community in which quality control is not prized - will sell investors anything they will buy. Second, speculation is most dangerous when it looks easiest."

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