Investing IN Something

By Rob Landley (TMF Oak)

GAITHERSBURG, MD (December 17, 1999) -- Last Friday afternoon, I watched a pair of talking heads on CNN discussing the previous day's record-breaking initial public offering (IPO) of VA Linux Systems (LNUX). They were surprised by it. I wasn't. There's a reason for this.

Real investors are never JUST investors. We have to invest IN something. A stock we buy represents shares of ownership in a company, and it's a darn good idea to understand what that company does for a living if we want to share in its profits. We have to have some other area of expertise beyond income statements and balance sheets with which to find and evaluate companies.

Personally, I've been banging on computers ever since I got a Commodore 64 when I was 12 years old. I majored in computers in college for the easy A's, because I'd already learned as a hobby most of what they were trying to teach me. Ever since I graduated, programming has been my day job. This is the reason so much of my personal portfolio is invested in tech stocks; not because it's a "hot sector" but because it's the area in which I can make the most informed decisions about what to invest in and what to avoid. And yes, this sometimes even extends to familiarity with certain small, privately held companies like Red Hat, Andover.net, VA Linux, and LinuxCare that can go on to hold very successful IPOs. But that's not as useful a skill as it might seem, because there's a big difference between spotting a trend and cashing in on it.

Spotting a hot pre-IPO company doesn't mean I scramble to buy shares of it at the IPO price. I can't. The IPO shares go to big institutional investors who then re-sell them (at a profit) to individuals like you and me. Hot IPOs surge in price on their first trading day due to a supply squeeze, not because anybody wants to pay a dime more for their shares than they have to.

I don't even follow IPOs of companies I don't already know about. I know enough about biotechnology to follow the pharmaceuticals in the Rule Maker portfolio, but I wouldn't dream of trying to guess which hot new start-up has the wonder drug of the future. That's just gambling. I'm out of my league there and I know it.

The important thing to realize here is that even the people most familiar with these small "hot" companies don't invest in them BECAUSE they're having an IPO. They may like the investment opportunity in spite of its IPO status, but an IPO doesn't make any company a good investment, it just lets more people get in on whatever opportunity is inherently there.

This can be really frustrating when a thundering herd of "me too" day-traders pile on IPO stocks and bid them to insane valuations, especially in the cases where there's a good company buried under all that hype that's now trading at ten times what it's really worth. I read an article that said VA Linux was valued at $48 million dollars per employee, and even QuaVa says that's just silly. From my point of view, I like VA and would love to own a chunk of the company, but I'm not buying its shares at those prices. Many years of growth are already accounted for in that stock price, far more than I'm willing to predict. After all, VA isn't the only Linux company.

IPOs aren't where most money is being made in the market; they're just where a lot of volatility is, and volatility is what gets covered as news. My favorite kind of stock is the "up another 2% today" kind. The kind I can ignore for a month without missing much. The kind we invest in here. Quick doubles make me nervous when they can go away again just as fast, and I prefer not to invest in anything that requires an exit strategy. I'm just not that conscientious.

Speaking of investing here, it's time for my recommendation about where to invest our monthly $500. I'm going to go with Home Depot (NYSE: HD) this time around. We'll never get a Merchant King into this portfolio unless somebody champions it, and I guess I'm the logical guy to do that. Since Home Depot just made it into the Fool's new NOW Index, it seemed like a good time to suggest it. And since technically Home Depot isn't up for election, let me also add that I agree with Matt's vote for Coca-Cola (NYSE: KO) in yesterday's report.

- Oak