Spotify's DPO Leaves Some Things to Be Desired for Long-Term Investors

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In today’s episode of MarketFoolery, host Chris Hill and Motley Fool Total Income‘s Ron Gross talk about timing the market, Spotify‘s (NYSE:SPOT) DPO, and some big reporting changes from GM (NYSE:GM).

Spotify is live on the public markets, but the company has some pretty big warning signs that investors need to be aware of. Market timing can be tempting — especially when financial media outlets act as harbingers of doom for the economy — but holding on to your stocks will almost certainly pay off much more in the long run.

Meanwhile, GM ruffled some analysts’ feathers by reducing its sales reports from monthly to quarterly, but the change is setting it up for long-term improvement.

A full transcript follows the video.

This video was recorded on April 3, 2018.

Chris Hill: It’s Tuesday, April 3rd. Welcome to MarketFoolery! I’m Chris Hill. Joining me in studio, it’s Ron Gross.

Ron Gross: Hey! How are you?

Hill: I’m good! We’re both back from our respective spring breaks.

Gross: Yes. How was yours?

Hill: We’ll get to that.

Gross: OK. I want you to know that I brought a lot of notes, [shuffles papers] so this is going to be some show. I’m prepared.

Hill: This really is. That’s how you can tell that Ron brought notes, because you can hear them. Let’s hear that one more time.

Gross: [shuffles papers]

Hill: Yeah. If he didn’t prepare, would he be able to do that?

Gross: Exactly.

Hill: We’re going to dip into the Fool mailbag. We’re going to delve into the automotive industry. We have to start, though, with Spotify, which is going public as we speak. Again, this is a DPO, not an IPO.

Gross: Sure.

Hill: Why are they doing the direct public offering? It seems like the financial upside for them is smaller. Or, do I have that wrong?

Gross: Well, the company gets no money at all, and they don’t necessarily need it, so, OK. The reason you would do a DPO instead of an IPO is because it’s a shorter process, it’s less expensive, there’s no dilution because there are no new shares created, you’re just selling existing shares, and typically there’s no lock-up period, which is a period of time where the shareholders are not allowed to sell shares. Those reasons, I think, are valid. 

But then you have to say to yourself, do I want to buy shares in a company where an existing shareholder is selling their stock to me, and they’re probably an insider that knows way more about the company than you do? And the company is not raising capital for any type of future growth. So, that’s a decision every investor happens to make. I’m on record as saying a company should really only go public if it needs access to capital markets for growth, not because their investment venture capitalists or the insiders need an exit strategy, and this is kind of what that is, so count me as not a fan.

Hill: I was just going to say, safe to say you will not be buying shares of Spotify?

Gross: Right. But there’s actual risks to the company, too. In a typical IPO, you kind of know how much capital you’re going to raise, because the investment bankers are involved and it’s kind of set. You don’t know how the stock will trade after the company goes public, but you know how much money you’re going to raise. In a DPO, you’re not raising money, so it kind of doesn’t matter. 

It’s probably going to be a more volatile stock, at least in the early stages, with a DPO, because again, you don’t have the investment bankers looking after the stock in the same way. You probably don’t have the same research coverage, certainly don’t have the same research coverage from the investment bank or bankers that are taking you public, so the institutional banks are not as interested, let’s say. So, there are downsides. But, again, the biggest one for me is that the company is not raising money, it’s just that insiders are selling stock.

Hill: I don’t want to give Spotify’s management any more credit than they necessarily deserve, but I sort of want to assume that they have thought the investment banker piece of this through. I always like to imagine the conversations that happen in the conference rooms, and I have to believe at least one person at Spotify in that conference room when they were debating the strategy said, “Let’s be very clear about what’s going to happen here. The investment banking community has no incentive whatsoever to be nice to us, even remotely. And, by the way, they probably have incentive to not be nice to us.” All that being said, that makes me think that if they have at least thought that piece of it through, maybe they are confident in their business model.

Gross: Perhaps. I think they would be less confident in going this route if they actually needed to raise money in order for their survival or for some great growth opportunity. Since they don’t really need to, I think it takes the pressure off, and they can go this disruptive route. The typical investment banking IPO model hasn’t changed much in a very long time. Perhaps it is ripe for some sort of disruption, like direct offerings. But, again, it really depends if a company needs to raise capital or insiders are just selling.

Hill: Tomorrow’s episode of MarketFoolery is actually going to be a Facebook (NASDAQ:FB) Live event. So, if you’re on Facebook — and I think it’s fair to say that at least a few fewer people are on Facebook now than a month or so ago — but if you’re on, you can join our Facebook group, which is just Motley Fool Podcasts. We’ll be streaming the video live on Facebook tomorrow around 11:30 Eastern. 

Speaking of which, we got a question in our Facebook group from Avi in Folsom, California, who writes, “I’m wondering if The Motley Fool team can do a segment on why it’s better to hold long-term than to try to time the market. There’s a lot of indicators that the market correction is looming, like Warren Buffett and Charlie Munger sitting on cash, rising interest rates, etc.” I find it interesting that Avi is looking at these different things and concluding that a market correction is coming. But, then again, if that’s the case, he’s not alone, there are plenty of people, just turn on financial television.

Gross: We’re down 10%, aren’t we?

Hill: Yes. Although, our co-founder David Gardner and others, including myself, take issue with the term “correction” defined as a drop of 10%, as though a rise of 10% is incorrect. Anyway, in terms of the basic question of holding long-term vs. timing the market?

Gross: You want to time, you really do. I think institutional portfolio managers want to time, everyday retail investors and Fools want to time. But honestly, I think you’re better off not, even though sure, there’s probably some folks who have had success doing it, and they’re the folks who write a book or you hear about on CNBC. But for the most part, most of us can’t do it. And the reason is, first of all, it takes an incredible amount of attention. You have to be very hyper focused on not only your portfolio, but the markets. Most everyday investors are not that hyper focused on it. They don’t have the time or the desire to be that focused on it. 

But, even if you do have the time, it’s still incredibly difficult. I love an article that I saw from Forbes, which said, “Successful market timing requires two correct decisions: when to get out and then when to get back in. Guessing right once is a 50-50 proposition. Guessing right twice drops the odds to only 25%.” There are so many times where I have said, “All the Shiller indications, the Berkshire, the anecdotal, it looks like the market is overvalued, time to get out.” Then, do you know what happens? The market has another 20% up year. It’s very, very difficult. 

The reason I brought all this paper [shuffles papers] is because there’s a study I wanted to tell Fools about that I thought was really interesting. If you had invested in 1996, by the end of 2016 you would have had an annualized return of about 8.2%. If you missed the best five days of that period, your return would have dropped to 6%, significantly underperforming the market. And if you missed the top 30 days, you actually would have lost money. So, it really ups the ante here —

Hill: By the way, just to emphasize, over a 20-year period.

Gross: Right. Just five days over a 20-year period makes such a difference. And let’s face it, you’re going to miss some of those days if you’re trying to time. And selling a portion or all of your entire portfolio, it could take not only time, but could also be quite costly and terms of capital gains that you’ll be forced to pay for all the investments that you hold in a non-tax-advantaged account. So, if you don’t factor in the cost of capital gains, you’re not doing the math appropriately, either.

So, it’s tempting, I get it. There are times where I’m heavier in cash than not based on whether I can find investments easily or not. I think that’s OK, and I think selling stocks when you think their upside is limited is OK. But, to be a real market-timer, I think, is fraught with issues that will probably, in almost all circumstances, end up not turning out well.

Hill: The only thing I’ll add is, Warren Buffett and Charlie Munger have been sitting on piles of cash for years.

Gross: A very long time.

Hill: I’ve stopped counting the number of times that Buffett has come out and given an interview on CNBC and said, “Boy, the elephant gun is loaded, I’m ready to buy something, but I just don’t see anything cheap enough.”

Gross: And if you’re going to be a market timer, that’s the better kind to be. He’s not selling stocks, he’s just not putting new cash to work because he can’t find something that he likes enough. If you’re going to have to be a market timer, that’s the kind to be.

Hill: General Motors announced its monthly sales figure for March, and take a good look, everybody, because this is the last time General Motors is going to issue monthly sales numbers. The company said they’re moving to a system where they’re going to be reporting sales on a quarterly basis because it better aligns with their business, and the numbers are less likely to be skewed by one-off events like a major storm or what day of the week a holiday falls on, etc. I love this move.

Gross: I didn’t know which way you were going to go with this. I love this move as well. It’s not without consequences, because you anger a little some people a little in the short-term, mostly the investment community and analysts who have relied on these numbers, and economists who have relied on these numbers. And also, whenever you do something that is not the norm and everyone else is still doing it, there could be some downsides. But I think that’s in the short-term. 

It’ll be really interesting to see if all the companies follow suit and say, “Thanks for the cover, thanks for thinking of this,” because this makes complete sense. 30 days is not enough time to really separate, what’d they say, the real sales trends from short-term fluctuations. It’s just not. 

So, they might take some hits from analysts in the short-term, but good for them. I think, again, we’re long-term investors here, so you shouldn’t be using 30-day data to really make any investment decision. Quarterly should be plenty. That might even be too much data for the average investor, but we’re used to it. So, I applaud.

Hill: There’s a 100% chance in my mind — again, just in my mind, not in reality — that someone else is going to do this.

Gross: Sure. There are some folks. Tesla doesn’t do it, but, you know, [laughs] on a monthly basis, you could imagine it’s in the single digits. But, yes, I would imagine, eventually, I don’t know if it’ll be immediate, but other companies will jump on the bandwagon. This has happened in retail as well, with monthly same-store sales figures. I remember back in the day, 15 or 20 years ago, I was following a company and they said, “No more, we’re not doing that, we’re just doing it quarterly.” And I actually had the opposite reaction I have now because I was an analyst and I wanted that data. But I was naive, I didn’t really need that data, I was just used to it and they were taking something away from me and I was a big baby about it. I think this makes better sense.

Hill: I think this makes perfect sense for the automotive industry. Do you think it makes sense for the housing industry? Because that seems like it has more ripple effects in it. And I’m wondering if anyone in the housing Industry is looking at this and saying, “Maybe we should go to quarterly, too.” I don’t know, it feels like this is more cut and dry, where it’s just, this is just GM sales, and yes, maybe we can discern a little bit about Ford, Toyota, other automakers, etc. But, I don’t know, I feel like there would be a bigger backlash from the investment community if housing data started to go quarterly instead of monthly, then we will see a backlash on this.

Gross: I think there would be a bigger backlash from the economist community, especially those folks in the government or those folks in certain areas where they’re trying to predict GDP, and they’re using major indicators like real estate to help them do that.

Hill: You don’t want a horde of angry economists on the loose.

Gross: No, they’re vicious. Analysts would be bent out of shape, too, but I really think the ire of the economic community would be the highest.

Hill: How was the college tour? For those who missed it, Ron’s spring break involved taking his son to visit colleges.

Gross: Yeah. We started in Michigan, where it was cold. We made our way all the way down to Florida, where it was quite nice.

Hill: Delightful.

Gross: It was great. Nice father-son bonding time. My wife joined us halfway through. A lot of flying, a lot of driving, a lot of walking, but we saw some great schools and had a really nice time.

Hill: Was there a highlight for you personally? I’m sure your son’s highlights, whether they be related to the actual academic institutions or just the travel, I’m sure that would be different.

Gross: Well, seeing my daughter in Michigan, she’s a student there, was wonderful.

Hill: Sorry about the game last night.

Gross: Yeah, that’s OK. I was going to say, the other highlight other than seeing my daughter was, when we were in Atlanta, we went to the Elite Eight game and saw Loyola and Kansas State play. And immediately after, we went to a sports bar and saw Michigan play. It was a lot of great basketball that night, a lot of fun being there for the Elite Eight game. It was fun. And you? I know you had a big, big, big week.

Hill: The white sandy beaches of Central Pennsylvania. I’ve gotten a couple of questions from listeners about this. Long story short, had two other spring break trips planned and those fell through, both of them to much warmer destinations.

Gross: Climes, as they say.

Hill: I almost said climes. Ended up going to Central Pennsylvania, not known for its white sandy beaches, but discovered this fantastic resort in the middle Central Pennsylvania called the Bedford Springs Resort, which is in the town of Bedford, Pennsylvania. We had a fabulous time, despite the fact that the weather wasn’t all that great. It was one of those things where we said, we’re absolutely going to go back to this place because we had a great time, and the weather wasn’t good, which meant we weren’t able to take advantage of all the things that the resort offers in terms of outdoor activities, among them the pool. Fortunately, there’s an indoor pool. But, no, we had a great time. A lot of history to this place. This is a place that was built, I believe, in the 1840s. So, among other things, it was the Mar-a-Lago of the Buchanan Administration.

Gross: Oh, if the walls could talk.

Hill: This was back in the 1800s when presidents of the United States would just take several months off and be like, “I’m just going to go away for a couple of months.” Yeah, James Buchanan, when he was president, because he was from Pennsylvania and he had been to the resort years earlier, he thought, “I’ll go kick it there for a couple of months while I’m president.”

Gross: Nice.

Hill: Yeah, nice move.

Gross: Mini golf involved at all?

Hill: Not at the resort. There may be some in the area. But, no.

Gross: I played 36 holes of mini golf last weekend, that’s why I asked. [laughs] 

Hill: How did you do?

Gross: I won one and tied one.

Hill: Nice. Did it have the classic windmill?

Gross: It did not. It was a little simpler than that.

Hill: I feel like, if you’re going to have a mini golf course, you do whatever else you want on the other 17 holes, you’d better have one hole that has the classic windmill.

Gross: [laughs] That’s fair.

Hill: Ron Gross, thanks for being here!

Gross: Thanks, Chris!

Hill: As always, people on the program they have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don’t buy or sell stocks based solely on what you hear. That’s going to do it for this edition of MarketFoolery. The show is mixed by Dan Boyd. I’m Chris Hill. Thanks for listening! We’ll see you tomorrow!

Chris Hill has no position in any of the stocks mentioned. Ron Gross owns shares of Berkshire Hathaway (B shares) and Facebook. The Motley Fool owns shares of and recommends Berkshire Hathaway (B shares), Facebook, and Tesla. The Motley Fool recommends Ford. The Motley Fool has a disclosure policy.

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