IPO Stocks [How to Value Any Company and When to Buy]
For the most part, people are risk averse. We prefer not to take on any additional risk unless there’s an increase in expected return.
On occasion, however, we’re not risk averse.
We’re risk seeking.
When we go to a casino or play the lottery, we’re taking on risk despite the fact that our bets have a negative expected return.
Why? Because in some contexts, risk is fun. It’s entertainment.
Picking Stocks for Fun
Many investors like to pick stocks for fun.
For them, attempting to outsmart (and outperform) the market is an enjoyable intellectual challenge. (And for the record, I see nothing wrong with that, as long as they’re aware that the value is in the entertainment rather than in the likelihood of success.)
But what does this have to do with those of us who are buy and hold investors, who have no interest in picking stocks?
In short, we may want to attempt to avoid investments that carry a high entertainment value.
The most obvious examples of such investments are penny stocks and IPOs. Because so many people use them like lottery tickets, their long-term historical returns (as a group) are rather low, despite their high risk.
Further, some experts–William Bernstein in The Investor’s Manifesto, for instance–argue that a part of the reason for value stocks having slightly higher historical long-term returns than growth stocks is that growth stocks (especially small-cap ones) carry a higher entertainment value than value stocks.
In other words, it’s fun to try to pick the next Microsoft or the next Google, so many people try to do exactly that.
And in the process, they drive prices of small-cap growth stocks upward and returns downward.
The natural response, of course, is to actively seek to make your stock portfolio as boring and unglamorous as possible.
The less popularity or entertainment value an investment has, the better.
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