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What Snap’s IPO Can Teach You About Intrinsic Value

And what millennial stock buying habits show us about the coming stock market crash

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A few weeks ago, I wrote about the hype leading into the Snap IPO. If you're unfamiliar with the company, Snap is the parent company of the popular app Snapchat.

With Snapchat you can take pictures or videos that disappear after a short time and send them to your contacts. They are at the front-end of a type of communication that is growing in popularity called ephemeral content, which simply means content that lasts for a short time. It's monetizes this service by attracting brands to the app to tell their own stories. These companies pay a premium to have their stories promoted to users feeds.

The demographics of Snapchat are very young. Of the over 200 million users, 37% are between the ages of 18 and 24, and only 14% are over the age of 35.

In my article, "It's Good to Be an Entrepreneur," I wrote about how Snap was valued at potentially $25 billion even though:

As the WSJ report, according to Snap's S-1 public filing, "Among the revelations, the five-year-old company posted revenue last year of $404.5 million, up nearly sevenfold from 2015, as advertisers flocked to its vast audience of 158 million daily users in the fourth quarter, which is concentrated in the coveted 18-to-34-year-old demographic. The company's net loss, meanwhile, expanded to $514.6 million as it spent heavily on everything from data storage to marketing and research."

Yes, you read that right. Snap lost around $114 million last year.

I also wrote:

And according to another article by the WSJ, "Snap's slowdown in user growth coincided with rival Facebook's launch in August of Stories on Instagram-direct competition to a Snapchat feature which lets users create a series of videos and images that disappear after 24 hours. Five months after the launch, the new Instagram feature reached 150 million daily active users, Facebook Chief Executive Mark Zuckerberg said on an early February earnings call."

Finally, I discussed how Snap was issuing non-voting shares and that the co-founders had 89% control of the company.

As I wrote then, "This, my friends, is the ultimate con. A company with no financial rigor raising over $3 billion from investors who have no say in how that money is spent."

And it's an ultimate con that worked like a charm.

The Snap IPO share offering was $17 a share, valuing the company at $23.6 billion. By the end of the day, "The stock closed at $24.48 on the New York Stock Exchange on Thursday, well above the initial public offering price of $17 per share on Wednesday, giving the company a market value of $28.3 billion, on a par with CBS Corp (CBS.N) and Target Corp (TGT.N)."

Since then, the stock has fallen about 10%, the co-founders have cashed out about $1 billion in stock, and most institutional investors have already cashed out. The only people left holding the stock are the suckers.

This begs the question, who are these suckers?

They're the very same people who comprise its user base: millennials.

Writing for "The Wall Street Journal" Moneybag blog, Ben Eisen talks about a popular trading platform with the younger generations, Robinhood, which allows for commission-free trades in exchange for a $10 a month subscription fee.

Eisen writes, "Robinhood's demographic already skews to the younger side, with a median user age of 29, the company said. But the median age among Snap buyers on Thursday was even younger, at 26. (That happens to be the same age as Snap co-founder-and newly minted billionaire-Evan Spiegel.)"

In his blog post, Eisen shares some stories of millennials who bought Snap on the platform. One is 22-year old Rebecca Shoenthal, who bought four shares of Snap. She paid $24 for each share, but she was willing to go as high as $40 per share.

Shoenthal "wanted to test the waters and play around with some money I wouldn't be too devastated to lose," which is good because she's already down. The stock is currently trading at around $22.

Eileen shares another story of 29-year old Kaleana Markley, who bought $100 worth of Snap shares. "She doesn't do much investing generally, citing student loans and the high cost of living in the Bay Area, but got excited by the talk of the IPO."

Why would millennials want to invest in Snap?

The reason Shoenthal decided to invest in the company as her "first big stock pick"? "She's gotten interested in stocks this semester because of classes she's taking on personal finance and branding. She thinks the prospects for Snap are bright, particularly given that Snapchat is changing the way many young people, including her friends, read the news."

For Markley? ""I think they are doing really cool things." She also cites the fact that her parents now use Snap as evidence of the company's growth potential. She "has high hopes."

Writing for Reuters, Angela Moon shares 25-year old Chris Roh's analysis; "I bought it even when I was pretty positive I would not make a profit in the short run, but just because I am a fan of the product." He bought his shares at $25 each.

Tiffany Dun, who's in her late 20s, purchased 125 shares in Snap for $22 a share. She told Moon, "There's always risk to everything. I use the product and I like it, so I bought some."

Moon also shares the insights of Stockpile's Chief Commercial Officer, Dan Schatt, "Snap is tapping into the pride of ownership (for millennials) which we don't see often in the stock market…Snap is offering the comfort of buying something that you know so well, understand and use it every day, which is what these young investors want."

Of course, the reality is that there is no true ownership for these millennials. All they own is a piece of paper that goes up and down in value, seemingly like magic, tied to no true fundamentals. It is a vanity stock, fueled by a love for a product.

Ultimately, this is a classic example of "investors" who purchase for price and appreciation gone wild. And it's a tragedy because it is clear that these young people don't understand how to truly invest. No one has ever taught them the principle of intrinsic value.

Why value matters more than price

Warren Buffett is famous for talking about the "intrinsic value" of stocks. But while many people parrot this phrase, few know what it really means.

The good news is that once you understand intrinsic value, you may better understand why some investors make more money than others. You might also realize that you can find intrinsic value in investments other than stocks, such as real estate.

You'll also understand why the co-founders of Snap and all institutional investors sold about $1 billion worth of shares after the IPO.

Follow the bouncing ball

When the average investor thinks about making money, he or she usually thinks about buying low and selling high. For example, an investor buys a stock for $10 and sells it when (and if) it reaches $20.

This leads many investors to check their stock prices immediately first thing every morning; their day gets off to a good start if the price has gone up, and a bad start if the price has gone down. Many of these investors become addicted to watching their stocks rise and fall throughout the day. I have no doubt the young folks who purchased Snap shares are doing this very thing…and feeling miserable they're already down.

Warren Buffett doesn't do this, and neither do I. While the price of an asset is important, it's not something we watch on a daily basis. Buffett owns businesses rather than stocks, and he pays close attention to price only when he buys one. After that, he isn't really concerned if the share price goes up or down, nor does he care if the stock market is open or closed.

In very simple terms, Buffett looks for well-managed businesses that grow more valuable over time; consequently, he often refers to a business's value "compounding," or accelerating in value. This is its intrinsic value, and being aware of it is one of the differences between an amateur investor and a professional one.

Additionally, Buffett only invests in companies where he can have controlling interests through his stocks. He never wants to be in a position where he can't influence and control the growth of a company's intrinsic value.

Instead of buying into Snap, Buffett recently invested heavily in shares of Apple. As Fortune reports, "Buffett's investment in Apple now amounts to about 2.5% of the company. That makes Buffett, who for most of his career has shunned tech stocks, Apple's fifth largest outside investor, and probably its most active."

A real estate example

Intrinsic value may be easier to understand from a real estate perspective.

When I buy a piece of property, I, like Buffett, am only concerned about price at the time of the purchase, because price determines returns. For the long term, I focus more on the following:

  • Income (cash flow): This is often called positive cash flow after all expenses are paid, including my mortgage payment and taxes.
  • Depreciation (phantom cash flow): This appears as an expense when it's really income that comes from a tax break. This confuses many people who are new to investing in real estate; it's essentially income you don't see.
  • Amortization: This is income because your tenant is paying down your loan. Paying the mortgage on your personal residence is an expense, but when your tenant pays your loan down, it's cash flow.
  • Appreciation: This is really inflation that appears as appreciation. If your rental income goes up, you as an investor can refinance and borrow your appreciation out as tax-free cash, and have your tenant pay for the amortization of the new loan amount. In other words, it can be tax-free cash flow.

Together, these components amount to the intrinsic value of a sound real estate investment, purchased at the right price and well managed. They provide me with what I invest for-increased value and cash flow.

Investing vs. speculating

Investors who buy a property to sell, often known as flippers, invest primarily for capital gains. This is often taxed at higher rates if they spend their gains instead of reinvesting their money; to me, these people are speculators, not investors.

True investors aim for cash flow and increased value. Warren Buffett doesn't like to sell because selling shares triggers a tax, and a tax reduces his wealth. Those who know Buffett's formula know that he wants to compound his returns, not share them with the government.

Keeping an eye on intrinsic value

You become a better investor by training your brain to "see" what your eyes can't-the real value (or lack of value) in any investment, regardless of whether it's a stock, bond, mutual fund, business, or real estate. This is its intrinsic value, and most amateur investors miss it.

When Warren Buffett mentions the intrinsic value of a company, he is referring to many of the same things. The vocabulary he uses is sometimes different, but the concept is the same.

To sum up, the average investor only knows one way to make money: buying low and selling high. A professional investor would rather buy low, realize gains from other arenas, and let the asset grow forever.

I don't know how long this stock market bubble will last, but if the millennials keep investing like they did with Snap, it could be a big one, which of course means a big crash.

I'm sure the institutional investors will be laughing all the way to the bank.

Original publish date: March 14, 2017

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