Tilting the investing odds in your favour

If you’re like me, your email inbox receives a steady stream of correspondence from so-called daily deal websites.

Clearly many at the big end of town think there’s something to be said for the phenomenon – Cudo, Living Social, Spreets and Scoopon are a few of the names that would be familiar to many Australians and they have the backing of some serious media and retail players.

A crowded market

Cudo is a joint venture between Microsoft (Nasdaq: MSFT) and ninemsn, Living Social counts (Nasdaq: AMZN) among its shareholders, and Spreets is now owned by the local joint venture between Yahoo! (Nasdaq: YHOO) and Seven Media.

The granddaddy of them all is Groupon (Nasdaq: GRPN), the US-based site that went public last Friday. Well, granddaddy might be a stretch – the company that started the daily-deal frenzy only turns 3 this month.

Now when people are prepared to pay many billions for a company like Groupon, you’d imagine a business with a long track record, insurmountable competitive advantage and large profits, right?

Paying up for potential (they hope!)

Not so fast. As I’ve already mentioned, Groupon is only barely out of its corporate nappies. No-one really knows how the business will perform when times get tough, whether customers will keep coming back, what the competition will look like, or how sustainable its profits are.

And yet the market is valuing it at upwards of US$16 billion after the first few days of trading.

Put me down as sceptical. I’m not prepared to predict its demise at this point – the short history of both the company and its market mean that history is no guide either way – but I’m certainly not prepared to put my money on the line.

A fairytale in the making?

Groupon’s IPO success makes it the stereotypical ‘story stock’. Investors in these types of companies are less focussed on this year’s numbers, looking instead at the possibilities. They can see futures for these businesses that make today’s price look cheap.

Sometimes, those stories come to fruition. Who among us wouldn’t have liked to get in on the ground floor of an Amazon or Fortescue (ASX: FMG)? The problem is that these ventures are the successful few, dwarfed in number by the unsuccessful many.

Or a nightmare on the way

In the United States, the late 1990s tech crash might have stopped many potential IPOs in their tracks but a decade later, the rush of listings from the likes of professional social-network provider LinkedIn (NYSE: LNKD) internet music streaming business Pandora (NYSE: P) and real estate information provider Zillow (Nasdaq: Z) suggests the market’s appetite for businesses with a good story is back with a vengeance.

Our market doesn’t tend to have the same opportunities in technology or biotechnology that the US markets do. Instead, our stories tend to be ones born from a couple of centuries of experience – miners. Many a small miner has listed on our markets over the years, each hoping to be the next BHP Billiton (ASX: BHP). Some, like Fortescue, manage to scale the dizzy heights, while others fall by the wayside.

As an aside, it’s interesting to note that during the boom, tech companies were using the shells of failed or failing miners to achieve so-called ‘back door’ listings on the ASX. Once the worm turned and tech companies fell out of favour, it was miners using former tech listings for the same end!

The rare few

Some investors, including The Motley Fool’s own David Gardner, have an enviable track record of being able to successfully separate the wheat from the chaff when it comes to these new, often disruptive, businesses. It’s a rare skill, and impressive to see in action.

For the rest of us, investing in those businesses in the absence of specialised knowledge or experience can be a little like playing roulette. Sure, if you win, you win big, but it’s far more likely that the house will have taken your money before your number comes up.

Foolish take-away

Successful investors take the time and make the effort to discover their circle of competence. To continue the gambling metaphor, in the words of Kenny Rogers, they ‘know when to hold ‘em and know when to fold ‘em’. They don’t play every hand the same way, and they only bet when they believe the odds are firmly in their favour.

I’m not sure how history will judge Groupon a few decades hence.

What I do know is that there are other businesses which fit more completely within my circle of competence and investing in that group dramatically increases my chances of being successful. Those are the only companies that really belong in my portfolio – otherwise I’m just guessing and hoping I’m right.

Are you looking for more quality stock ideas? You can click here  to request a new free report titled The Motley Fool’s Top Stock For 2012.

Scott Phillips owns shares in Microsoft and and has subscribed to too many daily-deal emails. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson. The Motley Fool’s purpose is to educate, amuse and enrich investors. 

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