This week’s impressive debut by Pinterest has cast a very interesting light across the social media/technology sector. While we await with anticipation the reaction of investors when markets open again next week, Pinterest is a different animal to the likes of Facebook and Twitter. However, if you look back at the debut of Snapchat and the initial rise of more than 50% from the IPO price, look at the shares today. Having been initially priced at $17 a share they very quickly hit $29 then fell to a low of $4.99 and are currently priced at $11.67. So what does this show?
Technology/social media companies are volatile
The whole concept behind technology and in many cases social media companies is the prospects for the future. Many investors are prepared to write-off the short term, together with an array of losses, as a means of gearing up for the long term boost in profits. We have seen this with many companies, the likes of Amazon was loss-making for many years due to significant investment in systems, software and hardware. Then suddenly, the majority of the ground work had been done and the company very swiftly moved into profit.
Valuing technology shares
When technology shares are loss-making they are almost impossible to value using traditional methods. There is no price-earnings ratio, no dividend yield and in effect no guarantee of a profit in the longer term. What we do know, history shows this, is that some technology shares will do very well and others will effectively curl up and die. So how do you hedge your bets when investing in the technology sector?
Spread the risk
One of the best ways to spread the risk amongst new technology shares is to buy into technology funds. These funds (taking in multiple technology share investments) are managed by experts who have a better knowledge of the inner workings of individual companies as well as, in theory, a better understanding of the direction of the technology sector. If for example one of their investments was to go under this might have an impact on the fund asset value but it would likely be negligible in the overall picture. However, imagine if you put all of your eggs into one basket and chose the wrong company. You could be wiped out!
Letting the dust settle
As we saw with Snapchat, it is sometimes better to let the dust settle when it comes to technology shares and especially new IPOs. An increase in the share price from $17 to $29 seemed to suggest that Snapchat was the best thing on the market. However, the collapse down to $4.99 showed how fickle the market is and how best to tackle new IPOs.
While companies come to the market for an array of different reasons, fundraising, profile, equity release, etc everything relies on demand. You will have seen many IPOs pulled at the last minute due to a lack of demand. As a consequence, the proposed IPOs which actually make it to the market tend to be popular with significant demand for shares in the early days. An imbalance between supply and demand can lead to a significant spike in the share price and then a subsequent fall. While nobody could have predicted the rise and fall of Snapchat, this does demonstrate this concept to perhaps an abnormal degree.