Value Investing

Why You Should Avoid IPOs

Warren Buffett is well known for his belief that you should avoid IPOs, a theory that Monish Pabrai also holds. In a recent interview with ET Now, Pabrai gives us some more insight into why he holds this view and why he believes, all investors should avoid IPOs if they want to do well over the long-term.

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More On Why You Should  Avoid IPOs

"There is a very simple rule of investing I follow, which is, never ever invest in any IPOs. So first off all an IPO is a company selling shares into the market. The company controls the timing, the company controls the story…. These are auction-driven entities basically tend to give us a pricing that goes to extremes."

Pabrai's logic for avoiding IPOs is very similar to that of Buffett. Both value investors believe that IPOs are more like lotteries than anything else and the pricing is entirely unrelated to the underlying business's value.

However, some IPOs have made some people a lot of money. Is this reason enough to buy? No say Buffett and Pabrai. At Berkshire's 2016 annual meeting, Buffett said "You don't have to really worry about what's really going on in IPOs. People win lotteries every day..." He went on to remind listeners that just because a strategy works for one investor doesn't make it a good idea. "If they want to do mathematically unsound things and one person gets lucky... it's nothing to worry about," Buffett said. "You don't want to get into a stupid game just because it's available."

And Pabrai holds the same view. Here's his reply when asked about an alternative strategy to buying IPOs:

"You have to identify businesses where the management is not only honest but they are also highly competent and they are going to go for growth. Also, you have to go for businesses where they are strong tailwinds and which are producing and gushing cash, producing a lot of cash and when you get that combination at a reasonable price, that is when you step in. The rest of the time you do nothing."

...

"Do not get envious because your stupid neighbour is tripling his money every three months and he is rubbing it in your face. Do not worry about that. Focus on long-term compounding. Focus on the 15% a year and those sorts of things. Do not try to do 15% a month. Generally speaking, you are going to hurt yourself more than you help yourself."

If you're interested in discovering Monish Pabrai style value ideas, you should sign up to ValueWalk's exclusive value magazine Hidden Value Stocks. Click here to find out more.