Why I Won’t Be Buying Groupon Stock

This initial public offering isn’t likely to make you wealthy.

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The initial public offering (IPO) for Groupon has attracted a lot of investor attention. As almost everyone knows, Groupon is the two-year-old start-up which offers its subscribers significant discounts for a limited period of time. Companies seem happy to slash their prices in exchange for access to Groupon’s huge customer base.

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Groupon is seeking to raise as much as $1 billion in its IPO, which would value the company at about $20 billion. Massive profits are assured for the investment banks and mutual funds that participated in previous fundraising efforts for Groupon. By some accounts, these firms could quadruple their investments. The underwriters will also be winners. They include Morgan Stanley, Goldman Sachs, and Credit Suisse.

Many investors are salivating at the prospect of being able to own a piece of Groupon. They are mesmerized by the rapid growth of the company. It had only 212 merchants signed up in 2009. Currently, they have about 57,000. The numbers of subscribers increased from 152,000 in June, 2009 to more than 83 million in March, 2011.

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While those numbers are impressive, my advice to investors is to just say “no” to purchasing Groupon stock either in the IPO or the aftermarket. My negative views about owning Groupon stock have nothing to do with projections concerning the future price of that stock. I have no idea whether it will tank or triple in value. For individual investors, it really makes no difference. Here’s my reasoning:

Show me the money. Groupon has never made a profit and is unlikely to be profitable in the near future. It lost a whopping $389 million in 2010.

It’s buying its growth. While revenues grew by 2,000 percent last year, making Groupon one of the fastest growing companies in history, the cost of that growth was huge. The company’s operating expenses increased by almost 6,000 percent.

It’s got competition. Groupon’s business model is easy to imitate. Its success has inspired many competitors. That’s bad enough, but the size of the new entrants is intimidating. They include the really big boys: Yahoo, Google, Amazon, Microsoft, Facebook, and many others.

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These facts alone should not deter investors. There are many companies that went public while incurring massive losses. Patient investors were rewarded handsomely. Amazon did not post profits until almost 5 years after its IPO. However, here’s the single irrefutable reason individual investors (not gamblers) should avoid buying Groupon:

Individual stocks are too risky. There are many risks in owning individual stocks. Remember Enron, Worldcom, Lehman Brothers, and Bear Stearns? These companies were considered to be terrific investments at one time before they filed for bankruptcy or were sold for pennies on the dollar. The risk of owning any individual stock can be mitigated by owning a diversified portfolio of stocks. The easiest way to do this is by purchasing a mutual fund. The expected return of Groupon (or any other stock) is the same as the expected return of the benchmark index to which it belongs, but the owner of the individual stock has as much as twice the risk as the investor who buys a fund that tracks the index. An investment that carries more risk without the likelihood of greater return is gambling and not investing.

Groupon investors may, or may not, profit from buying the stock. Smart investors will hedge their bets and avoid all individual stocks, regardless of the lure of huge profits.

Dan Solin is a senior vice president of Index Funds Advisors. He is the author of the New York Times best sellers The Smartest Investment Book You'll Ever Read, The Smartest 401(k) Book You'll Ever Read, and The Smartest Retirement Book You'll Ever Read. His new book, The Smartest Portfolio You'll Ever Own, will be released in September, 2011.