Financial

Should I buy Morningstar?

Last Friday Morningstar, an independent investment research house, announced the terms of its upcoming initial public offering (IPO).  Morningstar will go public in a Dutch auction IPO on May 2, 2005.   7,612,500 shares will float at a price of $16-$19 per share.  At $17.50 per share Morningstar would have a market capitalization of just under $673 million, making it a small cap stock.  Morningstar will list on NASDAQ, and its ticker symbol will be MORN.  It will be the first high-profile Dutch auction IPO since Google’s wildly successful IPO in August 2004.  It is highly anticipated, and it could be another bellweather for other Dutch auction IPOs.

 

If you recall, I purchased shares of Google at IPO and did very well before I sold them earlier this year.  Google’s current share price is still less than what I earned when I sold my shares.  Because of my Google experience, I am very bullish on Dutch auction IPOs.  IPOs are traditionally the realm of insiders and institutional investors, but Dutch auctions allows small investors like me to get involved in initial public offerings.  Google’s IPO turned the investor hierarchy on its head, and small investors like me did very well.  We sat back and watched in amusement as large institutions such as Fidelity scrambled to catch up and buy Google shares weeks after the IPO.  I am hoping that lightning will strike twice through Dutch auction IPO, and I am contemplating buying shares of Morningstar at IPO.  It’s possible because I opened an OpenIPO account with W.R. Hambrecht, the bank that will run Morningstar’s auction.  (You too can open a Hambrecht account and still participate in the Morningstar IPO.  Don’t delay or you’ll miss it.) 

 

Purchasing shares of Morningstar at IPO is very attractive.  However, in the near term it may not be the best investment decision.  If I do purchase shares, I will only devote a small amount of capital to invest in MORN.  I believe that over the next few months MORN could return 25% or more above the IPO price, but there will be pitfalls.  I could be wrong.  For one, the market has been soft lately.  Many IPOs since Google’s have not done well.  Secondly, this IPO is highly anticipated, meaning that many investors will bid the price up.  MORN will likely debut at $19/share, the high end of its price range.  Thirdly, IPO stocks tend to dip a few days after IPO and can be purchased at a cheaper price than at IPO.  Fourth, Morningstar is not Google.  Its investment ratings system is an industry standard, but it is not a high-growth or tech stock like Google is.  Morningstar is also unprofitable, although it could be profitable in the coming years.  Much of the hype surrounding this IPO lies in the fact that it is a recognizable name using an unorthodox IPO method popularized by Google.  Fifth, Chief Executive Officer Joe Mansueto will still own 78% of the company after IPO and will have firm control over it.  He could nix any mergers or buyouts.  Lastly, Morningstar must also comply with a Securities and Exchange Commission probe currently underway and may face fines for impropriety. 

 

Still, here is why I believe Morningstar will be worth the investment.  For one, popular IPOs have done extremely well over the past year since the IPO market began to heat up again.  I also did well with DreamWorks Animation.  I missed out on the IPO but purchased shares on a dip the following week.  In addition, MORN is an industry standard in the financial sector, a sector with high growth potential.  In an age when investment banks must set up independent research houses to comply with terms of settlement reached with New York Attorney General Eliot Spitzer, Morningstar will shine.  Banks will have to buy independent research and will rely increasingly on Morningstar research and ratings.  The Dutch auction IPO will also ensure a fairer price for Morningstar, so the stock will not be substantially overvalued after IPO.  Finally, Morningstar will be a small cap stock with plenty of room for growth.  By contrast, Google’s market capitalization is already $56.20 billion, 83 times larger than Morningstar’s will be at IPO.

 

I am bullish on a few upcoming IPOs.  I would love to buy shares of investment bank Lazard, which will soon go public through a traditional IPO.  There are rumblings that the New York Stock Exchange will pursue an IPO in the future.  To that I say, “Buy, buy, buy!”  If no-frills classified web site Craigslist ever goes public, I would stand in line all night waiting to buy shares.  However, these will be traditional IPOs, and small investors will not have the opportunity to buy shares at IPO.  I prefer getting in on the ground floor with a company like Morningstar.

Can't buy a market

The U.S. stock markets’ performance has been lousy this year.  All the major indexes are off this year.  They’ve been negatively affected by news from Iraq and underperforming U.S. economic indicators such as the U.S. GDP growth rate and unemployment rate.  The price of oil is up to around $54/barrel.  The dollar has strengthened, but it is still very weak.  The trade deficit and federal budget deficits continue to grow.  Interest rates keep going up because the Fed is still mildly worried about inflation (of course, the price of crude doesn’t help–gas prices affect the entire economy).  Stalwarts like AIG and HP and formerly darling stocks such as Krispy Kreme have fallen in financial and regulatory trouble. There have been several large market losses this year and only a few modest gains.  What’s a small investor to do? 

I think now might be right time to begin investing again.  A down market cheapens stocks that should rise when the market rebounds.  It’s a simple fact that stock markets are cyclical.  During the doldrums of summer last year the markets tanked, and then 2004 ended with a bang following the presidential election.  2004’s market momentum unpredictably ground to a halt just days after 2005 started.  (The market usually has a good year after an incumbent president wins reelection.)  It’s important when investing not to focus too much on market peaks and valleys, because they tend to lead to irrational investing decisions.  At the end of last year, for example, I bought into (literally) the hype that Overstock.com will becomes a potent competitor to eBay.  Perhaps someday, it’s much too small now to become the next eBay.  Fortunately, I didn’t buy much, but I bought it at a very high price and the share price has since decreased by almost one-third since then.  The stock price might eventually recover, but I will likely sell it at a loss to recoup my loss.  On the other hand, I did not follow the crowd and buy DreamWorks Animation at IPO last year; I waited until its share price had decreased to a reasonable level and bought once the IPO euphoria subsided.  I sold it at a profit once other investors saw the value of the Shrek franchise and the fact that DreamWorks Animation is now a serious competitor to Pixar, a darling stock five years running. 

Although the depressed market is discouraging, I believe that now may be the time to assess what stocks, mutual funds, and bonds may be more attractive to buy (or sell).  Here’s a few suggestions if you’re interested in investing:

  1. Set a target price for both buying and selling investments. 
  2. Buy what you know.
  3. Choose investments you believe are undervalued and will outperform.
  4. Be patient; don’t panic when the investment rises out of reach or dips unexpectedly. 
  5. Do not day trade or buy and hold indefinitely.  
  6. Set a high and low target selling price and sell on schedule. 
  7. Don’t worry too much if the stock price of the stock you sold keeps going up; what goes up can and often will go down.
  8. Diversify equity holdings by buying mutual funds and bonds.
  9. It is preferable to sell individual investments prior to major announcements; don’t buy after an earnings announcement if the price swing is substantial (e.g. when Merck pulled Vioxx off the market last year). 

It is easy to get burned if you hold onto a stock indefinitely and continue to hold on to it while it tanks.  Too many people bought worthless investments and held onto them too long during the dot.com bust (2000-03).  For example, Infospace shares spiked in March 2000 at the equivalent of $1,300/share; today a share of Infospace costs $38/share.  Get in and out of a stock while you can.  Don’t waste your money buying at an exuberantly irrational market peak, and don’t watch your investment tank just because you think it will rebound.  Invest wisely.  Buy low at a target price and sell at a target price.