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Medibank Private Shares Pop, But Here’s The Uncomfortable Truth

G’day Foolish readers,

Medibank Private (ASX: MPL) aside, the ASX simply can’t take a trick.

I’ve got more, much more, on the Medibank Private IPO below, including an uncomfortable truth you may find a little disturbing, especially if you’ve just ponied up $10k to join the feeding frenzy…

But first, to the broader market, where things don’t look any better.

Last week was a horror show. The S&P/ASX 200 Index fell in every one of the week’s five trading sessions, in the process wiping out the whole year’s gains. It was the benchmark’s biggest weekly loss since June 2013.

After a brief respite yesterday, the market is on the nose again today… which is in stark contrast to U.S. markets.

Over there, they are dealing with a different type of problem — stock market high, followed by stock market high.

Problem, you ask?

Only if you’re still stuck in cash. Or still reluctant to buy U.S. quoted shares. Or worse, knee deep in gold.

Not so me. I’ve been buying U.S shares, again, using my still strong Aussie dollar to snap up some American-quoted stocks for my portfolio.

I’ve no shortage of candidates either, given Motley Fool Share Advisor, the subscription-only stock picking service I run with Scott Phillips, has a fist-full of buy recommendations on its scorecard.

I don’t like to boast too much, but in the three years we’ve been running the service, one U.S. quoted stock is up over 500%, three others have more than doubled, and two others are up more than 80%.

I’m not the only one going Stateside either, my colleague Claude Walker posting on the very popular and lively Motley Fool Share Advisor discussion boards that he is in the process of opening a brokerage account specifically to trade U.S. quotes shares.

Speaking of U.S. markets, in the wake of yet another all-time high, Bloomberg reports…

“U.S. stocks rose, extending all-time highs for benchmark indexes, as small-cap shares rallied amid growing confidence in the global economy.”

Europe pledges to raise inflation as fast as possible. China cut interest rates. Continued positive economic news out of the U.S., including strong corporate earnings.

Not surprisingly, all this “happy gas” promoted one pundit on Bloomberg to simply declare…

“This market has more upside potential.”

Meanwhile back here in the not-so-lucky-any-more country, the ASX investing world is totally fixated on the Medibank Private IPO. Trading of the shares commenced today at midday AEDT.

In early trading, Medibank Private shares have jumped to around $2.20, giving retail investors  — who paid $2.00 per share — a nice first day profit.

Congratulations! It’s a great start, a great feeling. There’s nothing better than a first day profit.

Based on a poll in the Fairfax media, about a quarter of ‘investors’ planned to sell their brand spanking new Medibank Private shares immediately.

For someone who applied for $20,000 worth of shares, that would see them pocket around $1,000 for the trouble of writing a cheque and filling out some forms.

Nice work if you can get it.

Splash out and buy yourself some nice wine, or an iPhone 6, or replace your 3-year old clapped out flat screen TV.

But please, whatever you do, don’t mistake your windfall with investing skill. Nothing could be further than the truth.

If you are a seller of Medibank Private shares today, you have a conundrum.

What do you do now with the rest of your sale proceeds, which could be as much as $10,000?

Stick it in the bank, earning 3%, before tax, if you’re lucky?

You won’t be alone, given households have close to $700 billion in deposits with Australian banks.

I feel for you. All that cash, earning a pitiful rate of return. Yes, it’s risk free. But at what cost?

Myself, I prefer a good old dividend-paying stock, preferably of the fully franked variety.

Like the one Andrew Page at Motley Fool Dividend Investor has recently recommended to subscribers of our brand new advisory service.

Out of respect to our paying subscribers, I can’t reveal the name of the stock.

But what I can tell you is the company dominates its niche, the shares fly totally under the radar, and best of all, the stock trades on a grossed up (fully franked) dividend yield of 7.7%.

It’s really tough to achieve outsized returns when you follow the crowd — something Medibank Private investors may find out, to their cost, in the years ahead.

As Andrew himself said…

“Often, the best returns come from a contrarian standpoint; looking past the superficial and uncovering a deeper perspective.”

But I digress… back to the stock of the day, Medibank Private.

Based off the $2.00 retail investors paid for the stock, the forecast dividend yield is around 4.2%. Not bad, but nothing to get too carried away about, especially given the yields on offer from other dividend paying ASX stocks.

I don’t like to rain on anyone’s parade, but if you are hanging on to your Medibank shares, I wish you luck.

I truly hope the experience turns out as well as it has for buyers of Commonwealth Bank of Australia (ASX: CBA) and CSL Limited (ASX: CSL), both “millionaire maker” stocks for those who bought at their IPO, held and reinvested the dividends.

That said, given Medibank’s premium valuation — at $2.20 the shares trade on a forecast P/E of 23 — the odds are stacked against you, at least in the medium term.

Once the IPO hype subsides — by about this time next week, if not sooner — investors will quickly come to realise the upside potential is limited, and the downside risk substantial.

Something seemingly lost in the whole Medibank Private IPO frenzy is that this is most definitely NOT a risk-free asset.

Of course, simply because Medibank Private shares appear fully valued doesn’t guarantee anything.

In the short-term, as fund managers and index tacking funds alike scramble over the leftovers from the massively over-subscribed float, demand for Medibank Private shares may continue to exceed supply, pushing the share price even higher.

But anyone who has been in the investing game as long as me — 25 years and counting — knows that eventually, it’s business performance that drives the share price higher or lower.

It’s what has pushed CSL Limited from an adjusted IPO price of 77 cents to above $79 today.

It’s what has seen Qantas Airways Limited (ASX: QAN) shares trade below their IPO price of $1.90, almost 20 years after they floated.

And for all the recent gains in the Telstra Corporation Ltd (ASX: TLS) — especially since we highlighted it in these very pages as our top ASX 20 stock, back in 2011 when Telstra shares were trading at $2.89 — they still trade well below their T2 float price of $7.40, coming way back in 1999.

Motley Fool Pro stock pickers Joe Magyer and Matt Joass have pegged Medibank Private’s fair value at $2.08 per share.

But, being bargain hunters, and wanting to limit the downside risk, Joe and Matt have stated their preferred buy price for Medibank Private is $1.66.

Based on the current share price, that’s almost 25% below where they trade today.

Seems impossible, huh?

Never say never.

Investing is a marathon, not a sprint. You don’t have to swing at every pitch. As master investor Seth Klarman says…

“You can wait for opportunities that fit your criteria and if you don’t find them, patiently wait. Deciding not to panic is still a decision.”

Panic refers to both buying and selling.

There is no need to panic-buy Medibank Private. If the stock’s for you, there will be plenty of opportunity to pick some up in the weeks, months and years ahead.

If the business is performing well, you may pay a little more for the stock, but it will be a less-risky investment.

If the business is performing badly, you may pick up a bargain. I bet, back in 1999, Telstra T2 investors NEVER thought they’d see their $7.40 shares trading as low as $2.89 twelve long and painful years later.

Just to be clear, $1.66 is not a prediction or a price target. It’s the price at which Joe and Matt would consider adding Medibank Private shares to the Motley Fool Pro real money, $1 million portfolio.

No hype. No feeding frenzy. No total disregard for valuation. Just sensible, stock market investing.

Speaking of which, Joe and Matt are dancing around the office today. Ozforex Group Ltd (ASX: OFX) — one of the holdings in the Motley Fool Pro portfolio — is up 8% today after releasing strong results.

Ozforex was once a hot IPO, at one stage trading 75% up on its float price. But panic buying quickly turned to panic selling when the company announced a slight slowing of client growth. As ever, Joe and Matt were ready to pounce.

That’s not to say the same fate could befall Medibank Private shares.

On the upside, it’s hard to see its shares trading at $3.50 any time soon.

But on the downside, especially given their premium valuation, although Medibank Private shares trading at $1.66 seems highly unlikely, never say never.

After all, we’re due a market correction.

And despite my repeated warnings that investors shouldn’t indiscriminately sell stocks just because the market is falling, we all know that when it inevitably does happen, panic selling will be widespread, and pervasive.

Buyer beware…

Until next time, as ever, I wish you happy and profitable investing.

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The Motley Fool's disclosure policy is accountable. Of the companies mentioned above, Bruce Jackson has an interest in Telstra and Commonwealth Bank.

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