Palm IPO Case Discuss Whether Any Biases Essay

Excerpt from Essay :

Palm IPO Case

Discuss whether any biases apply in regard to the Palm IPO to the analysts, investors, management.

Yes, biases on multiple fronts were present with all stakeholders involved. I believe it is important to look at these biases in regards to the prevailing market sentiments at the time. During the period directly prior to the IPO, the markets were experiencing excessive optimism in regards to technology stock. Technology stocks during this period were valued very high relative to their intrinsic worth. In fact, many companies during this period were trading at thousands of times their prior year earnings. In many respects, some companies commanded high prices with no earnings what so ever. This mass euphoria created irrational values on most companies in the market. The Palm IPO was a direct response to this mass euphoria surrounding technology stocks. Individual investors believing that stock prices could not come down were purchasing securities at very high prices relative to their intrinsic value. Analyst, who are following the stocks, and have a large investor following then provide incentive for individuals to purchase the stock through their "analysis." In many instances this analysis has very little merit to it. Biases towards the company provide a conflict on interest on the part of the analyst, the investor and management.

In regards to management, there is an incentive therefore to depict a rosier scenario in regards to corporate earnings. They have an inherent bias towards their company's performance relative to peers. The market is primarily composed of human beings making financial decision for themselves, their companies, or on an individual's behalf which further compounds the underlying issue. As such, emotions play a very important role in regards to business decisions on the management side and individual investment decisions on the analyst side. By simply being human, emotions can cloud otherwise rational judgment in regards to financial decision making. Management can therefore take advantage of this concept to artificially inflate prices as they did with the Palm IPO. The biases towards the recent performance of the business created an overly optimistic picture of Palm's financial standing (Eisenhardt, 1989). The analyst can therefore use this bias to help inflate the stock price of the underlying security higher through his recommendation of the stock. His recommendation, given the companies past performance, is then used by individual investors to make their investment decision. As long as management can continue to create a rosy and over optimistic view of his company, the analyst can continue to recommend the stock. The investor, listening to analyst opinions, and doing no research themselves, then purchases a stock that is clearly overvalued. The initial bias in management's assessment of the business trickles down to the individual investor in this instance. The analyst, who wants to promote the company's past performance, is also biased towards the company's products. In his "analysis" he mentions how create the product is, with relatively little mention of the actual price of the share or how much the share is actually worth. No product, no matter how exciting can command an infinite price.

Examples of these overly optimistic or pessimistic biases still occur today. Arguable the greatest crisis to occur within our lifetime was during the 2007-2008 fiscal year. Much like the Palm IPO period, there were many biases on the part of management, investors, and analyst than both helped and harm the individual retail investor. During this year, stock prices plummeted nearly 50%. Much like the Palm IPO case, biases on the part of investors were misplaced. During this period it was very difficult for the average consumer to be the slightest bit optimistic about the future prospects of America. In fact, extreme pessimism was the majority sentiment at the time. These emotional biases on the part of analyst, investors, and management directly correlate to stock pricing. The prices of stock during the height of the financial crisis were extremely depressed. This is the exact opposite of what occurred during the Palm IPO case. During the Palm IPO case, prices, due to the tech stock boom, were extremely elevated. However, the concept of biases still remains (Daniel, 1998). Due to the extreme pessimism that prevailed during these periods, companies who were financial strong had opportunities to acquire other firms. Executives actually enhanced shareholder value with the use of relevant information. JP Morgan acquired Washington Mutual and Bear Sterns for pennies on the dollar due to pessimistic emotions. Wells Fargo was able to acquire Wachovia as the market emotions depressed prices to bargain levels. Stocks of financially stable companies with fortress balance sheets, such as Wal-Mart, Proctor & Gamble, and Nike, were all trading at very depressed prices (Rothbard, 2012). They were conservatively managed and used asymmetric information regarding their future prospects to the advantage of shareholders (Aharon, 2010).

In the Palm IPO case however, investors, management and executives destroyed shareholder wealth due to the prevailing biases of the period. As mentioned above, this occurred primarily to the "get-rich-quick" investor who purchased stock believing the stock would immediate increase in value. Management, wanting to keep this momentum going to create wealth for them, created overly optimistic assessments and evaluations of business performance. Analysts, who were justified by the rapid price increases, added more incentive for investors to purchase the stock with recommendations that were not grounded on quantitative analysis. These biases ultimately lead to the collapse of the Palm price during the subsequent market crash.

Discuss whether Palm and 3 Com were efficiently priced on Palm's first day of trading.

Both Palm and 3 Com were not efficiently prices during the first day of trading. If they were efficiently priced, the extreme appreciation of the stock on the first day of trading wouldn't have occurred. Investors, due to the prevailing market sentiments at the time, believed the stock to be relatively undervalued. They based this assessment on biases within the overall market environment. An efficient price is one that aligns intrinsic value with that of the market value of a security. A good measure of this would be tangible book value. Book value is simple a measurement of a companies assets minus its liabilities. This would have providing a rough estimate of the company's true value. Palm and 3 Com however, were evaluated by the mass folly in the market. This psychological biases created an efficient pricing structure for many companies in the market (Rabin, 1998) as the case indicates, during the first day of trading, Palm was valued at $92.7 Billion. This was more than well established companies such as Disney or Boeing, who, at the time were worth far less in the market. Palm with a P/E ratio of 350 was not efficiently priced. If earning for Palm remained stagnant, it would take an investor 350 years to recoup his initial investment! This, I believe, provides convincing proof of the inefficient pricing prevailing during the companies IPO. The investor must be more rational in the price he is willing to pay for earnings of a newly formed company (Hogarth, 1987). There is very little justification for paying $165 for a company that is valued nearly doubles that of Walt Disney Co. As such, it is my contention that the company was priced inefficiently during the first day of trading.

Analyze the assessment of Palm made by analyst Paul Sagawa.

As mentioned briefly above, the assessment of Paul Sagawa was not grounded on quantitative reasoning. Instead, his assessment was grounded in the qualitative assessment of the products quality. As the case describes, Sagawa was bullish on the companies stock because it was cheap and had enormous upside potential. However, Sagawa fails to provide clarity as to what price an investor should pay for upside potential. Potential furthermore is often different for actual performance. A company may have great potential, but fail to deliver on this potential. With the high prices that Palm was commanding in the market, a small deviation in this potential would result in a catastrophic collapse in the stocks price. Sagawa however, fails to mention the extreme downside of purchasing a stock with a P/E ratio of 350. Instead, much like many of the prevailing analyst of the time, he focused his efforts on the "potential" of the stock without much consideration to the downside if he is only marginal incorrect in his assessment. Furthermore, he was more enthusiastic about the stock once his wife purchased it. Again, this has nothing to do with the intrinsic valuation of the company. Great products often times do not make great stocks. The auto industry for example revolutionized the way in which the world travels and does business. Henry Ford in 1914 created one of the best industries known to man, with his creation of the auto mobile. However, nearly 100 years later, America only has 3 auto companies with 2 of them going bankrupt in 2008. The consumer was very happy with the cars; however the investor was unhappy with his individual returns on investment. Likewise, the…

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