Brad DeLong's Semi-Daily Journal (2004)

You are wrong. I too went to economics school and believe in intrinsic value. I also spent a couple of years as a bond trader - And it's all about what other people think is true. It's nothing about what is REALLY true. If you start trading on intrinsic value you will lose. A case in point - If you really believed in intrinsic value you would have missed the last 3,000 points of the runup in the NASDAQ in the 90's. So when you go to play the markets, dont pay any attention to what you learned in grad school - it wont help. What helps a lot more is reading newspapers and haggling with vendors in street markets in third world countries. Trading is more or less the same wherever you go.

If you start trading on intrinsic value you will lose. Intrinsic value isn't for traders, it's for investors.

But how can you guage the psyche of the market if there is no market yet? Also, Prof. DeLong qualifies his comment by limiting to "long-term" investors. Trading is a whole different game. First, few people have access to the information (computer systems) to watch the market second by second. Fewer people have the stomach for trading (this may be wrong based on what I hear about Las Vegas).

But how can you guage the psyche of the market if there is no market yet? Also, Prof. DeLong qualifies his comment by limiting to "long-term" investors. Trading is a whole different game. First, few people have access to the information (computer systems) to watch the market second by second. Fewer people have the stomach for trading (this may be wrong based on what I hear about Las Vegas).

Brad's point is to determine how much the shares are worth TO YOU, and bid that amount. If the market says the shares are worth more, you aren't getting them, because they are priced more than they're worth TO YOU.

alan has it exactly right with respect to steven kyle's remarks: we are talking apples and oranges.

Trading and investing are two different animals. I am sure there are brilliant traders out there who, in the long run, make a lot of money, but i don't know any of them, either personally or reputationally.

On the other hand, i know there are plenty of value investors out there who make a lot of money, and whose results are a matter of public record, which is why i make my investment decisions on an intrinsic value basis.

After all, the flip side of "missing" the last 3000 points of the NASDAQ runup (which i did) is that you miss the the first 3000 points of the NASDAQ collapse (which i also did)....

IPOs attact a lot of attention because people think they can get rich quick. Unless you are in on the ground floor (like Terry McAuliffe and GHW Bush in Global Crossing) the deck is stacked against you. Even if you come up with a good price guess, your bid may not have enough priority to be accepted. The long term strategy is to wait a couple of months for the dust to settle then buy at a more stable price that is well below the initial overreach. Enough people have been burned by IPOs that caution should be advised.

Isn't the real point that the entrepreneurs that
were responsible for creating something new that inproving our standard of living will get most if
the rewards and will not have to give so much of the receipts to a bunch of traders that just flip the stock as a reward for giving business to the brokerage house.

Flipping IPOs was one of the biggest waste and economic inefficiencies of the bubble and most of the bad mouthing of the auction comes from the people that are missing out on another free lunch.

But this time it's different.

The internet changes everything.

You just don't get it.

I've always wondered if a good idea for a mutual fund was one that traded in 2 or 3 years old IPOs.

As general rule a hot IPO market is a sign that the market is approaching a peak.

Steven and Alan -- Brad did NOT say that the potential buyer should calculate Google stock's intrinsic value. Read a little closer: he said, if you are interested in buying this stock, only "what price the market will place on Google shares" is relevant.

That is, he's saying that Blodget's claims that you must both figure the _market_ price AND "game" the market price are wrong. Blodget is wrong, I would think (not a trader OR an economist, here!) because the market price (_not_ the "intrinsic value") will _already_ contain the net result of all gaming by all players. That's what "market price" means! Blodget is saying one thing three times, but in a way that is likely to skew, rather than improve the potential investor's calculation.

OK...whoops...Brad DID say "estimate the intrinsic value" -- though as part of a process of guessing the market price, not as a basis for an actual bid.

My goof....guess I'm the one who needs to read more closely!

Maybe I'm being naive, but isn't the price already being determined. Won't the institutional firms be making the lion's share of bids and volume, thus determining clearing price?

I certainly don't expect these firms to collude in fixing a price - their self-interest would keep them from doing that, right?

How do you estimate intrinsic value? If there is a good way of doing it, why does anybody do anything else?

Jack, you estimate the discounted value of all future profits/dividends (discounted by both time and market correlation). It takes a bit of work, and you'll only come up with a rough guess, but if you do so, the number you come up with will be one you can be comfortable with.

Trying to second guess the market or play "Who's the greater fool?" is a way to make sure you don't make money fast (a few day traders make money, but as a whole they lose money in much the same way as people at a sportsbook lose money).

Jack, this is the question, isn't it? The simple answer (that helps you not at all) is that the intrinsic value is the net present value of the future earnings stream. That begs the two critical questions: what's the future earnings stream, and what's the discount rate, which is where the calculations either come undone or don't.

By and large, the reason that people don't simply calculate intrinsic value is because they can't answer those 2 questions, so they utilize other methodologies to try and make money in the market.

A good place to start is Ben Graham's The Intelligent Investor....

Hang on a minute.

Suppose I've decided, for whatever reason, to believe that the shares will, sooner or later, rise above the price set in the initial offering.

Given that assumption, and the nature of the sale, isn't it in my own best interest to bid far more than my estimate of the minimum auction price, in order to secure my shares? After all, there's no penalty for this behavior— I won't have to pay for my sky-high bid, right?

After adding in another bit of game theory I've been mulling over (hint: voluntary markets systematically underestimate risk), I think I'll be sitting this one out.

Jason,

To the extent that intrinsic value has any meaning it means roughly what you say: the present discounted value of all future cash flows. The problem with Brad's reasoning is that future cash flows inclue a possible future sale price -- which depends on what other people think a thing might be worth.

'Course this is a phoney answer to the whole thing, since it just switches you from asking about price to asking about the discount rate you should apply, presumably "your" interest plus your chosen risk premium, a random variable entirely dependent upon your mood at any moment.

Robotslave,
I don't understand your point. Suppose that an investor thought the intrinsic value was $100 per share, but bid $1000 per share to assure that the bid was accepted. Now suppose that the final clearing price was $500 per share. This would seem to be a bad thing. Why would a rational investor do this? What game theory element am I misunderstanding?

Keith:

I did not posit a potential investor who has some notion of the "intrinsic value" of the share, I posited an investor who is confident that the price will, sooner or later, rise above the level determined by the auction, whatever that may turn out to be.

Note that an investor who believes in that old chestnut, that "stocks, in the long run, always go up," would qualify.

Well, the discount factors for time are relatively easy to find, they should just be the rate on government bonds (not entirely risk free, but close enough). The discount factors for risk (note, only that risk correlated with the market, other risk should affect how much *you* buy, but not what you feel a fair price is) are the trickier thing to estimate - you need to think about how things that affect the whole market are likely to affect this one companies cashflow.

Keith,

Robotslave's argument is exactly right. Given the uncertainties of calculating 'intrinsic value', IF you want to buy the IPO AND you are confident that the price will rise post-IPO, you should ignore intrinsic value and bid high.

Of course, there is a very small chance that YOUR sky high bid could end up being the market clearing bid. In that case you have made Google really, really happy and made everyone else really really mad.

However, Blodget's column now explains why he was so spectacularly wrong with his $400 price target for Amazon in his heydays. He obviously played game theory once too often.

Ignoring intrinsic value is playing who's the greater fool. People do it all the time which is why (daytrading) pyramid schemes make so much money for all those who participate.

Robotslave,
Ah, I see your point now. I suppose that this thinking is so far different from mine that I had trouble grasping what you were saying. But you are right--there probably are some who think like this.

But while figuring out your "allowance" for being overoptimistic, don't you have to figure out how other investors arrive at their estimates of intrinsic value and bids, a la Blodget's directives 2 and 3? Assuming plausibly of course that you are uncertain about your own estimates, and do not dismiss the estimates of others out of hand.

But while figuring out your "allowance" for being overoptimistic, don't you have to figure out how other investors arrive at their estimates of intrinsic value and bids, a la Blodget's directives 2 and 3? Assuming plausibly of course that you are uncertain about your own estimates, and do not dismiss the estimates of others out of hand.