I fielded many inquiries about the Facebook IPO from clients and readers of my books last week. They all had the same question: Should I buy the stock? I gave them all the same answer: No.
I had no idea the stock would barely move off its offering price. According to Yahoo Finance, it closed at $38.23, up a pathetic 23 cents. While my advice was not premised on the closing price of the stock, many industry gurus weighed in with their opinions. The predictions most interesting to me were those of Silicon Valley’s elite venture capitalists. If anyone had the expertise to make this kind of short-term prediction, you would think it would be those who make the decisions about investing in what they hope will be the next Facebook. How did they do?
According to an article at VentureBeat.com, the predictions of ten top venture capitalists ranged from a low of $45 to a high of $63. How could these experts get it so wrong?
The CXO Advisory Group may have the answer. It accumulated reviews of the public U.S. stock market forecasts of 60 experts for more than two years. The results weren’t encouraging. Bond king Bill Gross had an accuracy rating of only 46 percent. James Dines was 49 percent. Jim Cramer was 47 percent. Not a single guru achieved a rating of 70 percent accuracy, and most were in the 30 to 50 percent range, which is less than you would expect from random chance.
I make no pretense of any ability to forecast the future price of any stock. I advised against buying Facebook for a reason that may surprise you: I don’t think investors should own any individual stock. Before you reject this premise out-of-hand, consider the basis for my views.
First, the primary reason investors purchase individual stocks is because they believe they are undervalued and likely to appreciate. However, the price of all stocks is set by millions of traders every minute of every day. These traders take into consideration all publicly available information about the stock and factor that information into the price. The price set by the collective wisdom of those traders is unlikely to be too low or too high. It is a fair price. Buying stock based on a belief that it is undervalued means you are betting against the views of those investors. I don’t like your chances.
Second, consider the risk of owning any individual stock. Remember Enron, Lehman Brothers, WorldCom, and Bear Stearns? At one time, many people thought these stocks were great buys. They all filed for bankruptcy.
How about Groupon (GRPN)? It started trading on November 4, 2011 and closed at $17.50. On May 18, 2012, it closed at $11.58, according to Yahoo Finance. On June 16, 2011, I wrote a blog entitled Why I Won’t be Buying Groupon Stock. I did not know the stock would decline in value, but I reiterated my view that holding any individual stock is too risky for most investors.
Risks unique to individual stocks can be mitigated by holding the index to which that stock belongs. You may or may not do better than holding the individual stock, but you will have less risk and it is likely your return will roughly approximate the return of holding one stock.
Here’s the lesson you can learn from the Facebook IPO: Trying to pick a stock winner is more akin to gambling than investing. A more prudent option is to focus on your asset allocation and invest in a globally diversified portfolio of low management fee stock and bond index funds.
Dan Solin is a senior vice president of Index Funds Advisors. He is the New York Times bestselling author of The Smartest Investment Book You'll Ever Read, The Smartest 401(k) Book You'll Ever Read, The Smartest Retirement Book You'll Ever Read, and The Smartest Portfolio You'll Ever Own. His new book, The Smartest Money Book You'll Ever Read, was published on December 27, 2011.
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