The first day of stock trading for LinkedIn was spectacular as the stock soared from an opening $45 a share to close above $90 a share. LinkedIn is a professional networking website. Individuals join LinkedIn. They can search for jobs, recruit employees, or find industry expertise. It is possible to post a resume or personal profile for free if you pay to join. Over two thirds of company income comes from subscriptions. The company business model has been successful as evidenced by its growth. The investor enthusiasm seen on the first day of stock trading has some concerned, however. It turns out that historically companies that have a spectacular first day of stock trading do not necessarily do well in the long term. This is not about the performance of the company but about the performance of the stock. A little investment research on LinkedIn shows, for example, that employee stock options come to nearly a fifth of the value of the company. Market insiders are referring to the quickly doubled stock price as a little rich or frankly as overpriced.
How to invest in stocks is to evaluate the fundamentals of a company, its intrinsic stock value and its margin of safety. This applies to the first day of stock trading and to established stocks. Then an investor will look at current aspects of stock price including price to earnings ratio. When a stock doubles in price in one day without a change in earnings it implies a substantial change in investor sentiment. The long term investor needs to decide if the change in sentiment will last of if he should take his short term gains and look for another promising stock. In order for LinkedIn to support its current stock price it needs to continue very rapid growth. If not we can expect to see a correction, perhaps by half, if history is a guide.
What is a good investment? Is buying an IPO on the first day of stock trading a good idea? It certainly was for those who purchased at $45 a share and sold a few hours later for a $45 a share, or more, profit. The question to consider is how about buying later in the game? Did folks who bought at $90 a share expect the stock price to double again? Were they expecting a 10% gain and planning to take a profit as soon as the stock hit $99? This question need not only apply to an active first day of trading. Many stocks have fast and substantial run ups. When the fundamentals clearly support the rising stock price the decision to keep buying is relatively easy. When market sentiment more than intrinsic stock value and margin of safety drive stock price it is often time to get out. However, another option, especially for those holding stock that has gone up in value, is to buy puts on the stock in question. The investor can keep the stock as he may well expect to see the price rise farther. However, he is protected against a fall in stock price as he can always exercise the put contract and sell at the contract price even if the market price has collapsed well below its high price on the first day of stock trading. As always we are not suggesting that buy or sell LinkedIn. We offer the above discussion about the first day of stock trading as a guide to stock investing in general.