The Sad, Cautionary Tale of Pets.com

From IPO to bankruptcy in less than a year.  And no one saw it coming?

Today, we are hearing a lot of hype about Internet companies and other start-ups.  And we want to hear the hype, coming off a bad market, and looking for Genies to turn our portfolio around.  And if you wish hard enough for a "sure thing" it may seem to appear.  But it may just be a mirage.

At the height of the dot.com bubble, Pets.com did an IPO and less than a year later (268 days to be exact) it was liquidated.

And if you read the history of the company, it isn't hard to see why - and it makes you wonder if some skullduggery wasn't involved.

They sold products for less than they paid for them.  This is a bad business model, to be sure.  But on top of that, they spent millions on advertising - Superbowl commercials and even a Macy's Day balloon.  There literally was no way they could "grow" out of their problems, and each additional sale actually put the company further into debt.

So who made money on this fiasco?  Well the firms that set up the IPO all cashed in, no doubt, and the founders who sold out their shares at the height made money.  The institutional investors who bought shares cheaply and then sold them to chumps like you and me (who bought them, based on the cute sock puppet and the immense advertising campaign) made a fortune as well.  And of course, the CEO, CFO, and other high-level employees all drew in top salaries.

Now, if you were cynical, like me, you might start to think that perhaps that was the idea all along - to create a company that never was intended to make money - but would garner a lot of publicity and generate a lot of interest.  Do an IPO, get Joe Investor to buy into it, and then cash out and let it all fall apart.

As Mel Brooks put it, in The Producers, you can make more money from a flop than from a hit.

And this is indeed true.  Selling pet food is a marginal business.  You buy the pet food and then sell it for a very slight mark-up.  Most pet stores sell pet food at or near cost - just as gas stations sell gas at or near cost.  They hope you make a more profitable ancillary purchase, such as that of a pet toy or other item.

And that never happened with Pets.com - they just kept hemorrhaging cash until they went under.

Now today, there are some money-losing companies out there that are getting a LOT of publicity and talk.  And some of them, like Facebook, have never made a penny in profit and are being very secretive about their financial workings.  Others, like ZipCar, have never made dollar one, and yet people are going nuts over-paying for the stock.

Are these sound buys, or just the echos of Pets.com?

When you buy a stock, ask yourself this:  Are you buying it because of the brand name and because you heard about it on a financial channel?  Or are you buying it because you reviewed the company's finances and feel it is a sound investment?

For most of us, the answer is the former - because we have neither the time or the means to access a company's detailed financials, and at best we can do is look at the stock price (what others think it might be worth) and the P/E ratios, plus the "buy/sell/hold" recommendations of a lot of analysts.

Speaking of which, this website has a nice summary of analysis recommendations (the link shows the recommendations for ADM, which I was researching recently).  Note that of the hundreds of analysts, the recommendations as to buy/sell/hold, etc. are all over the board.  Helpful, ain't it?

Just as helpful as the sidebar ad from Motley Fool predicting a "Market Crash" - selling FEAR again!

So, what is the answer?  There are several, I think.

1.  Walk away from hyped companies and stocks, like Facebook, ZipCar, Groupon, or whatever.  When they do an IPO (and they always do an IPO) they are counting on you, the consumer, to pay top dollar for the shares.  You are buying little more than a brand name and hype.

2.  DIVERSIFY YOUR PORTFOLIO - and this means owning your home outright, owning some investment property (that makes money, not loses it), some stocks, some bonds, some mutual funds, some government debt, life insurance, annuities, some - well some of everything.

3. Realize that the best bets are probably in companies whose brand names you never heard of:  Some obscure industrial supply company might churn out regular profits.   But since you never heard of the brand name or saw it on the grocery store shelf, you'd never buy it.  It is tempting to buy stock in companies whose products you use, but it is often a fool's errand.  And this is one reason mutual funds are a good adjunct to your portfolio - they often invest in things you never heard of, but should be invested in.


4. Stop Trying to Beat the Market:  Stock picking and timing the market are hard for the big boys to do - and nearly impossible for you to do.  What will end up happening, if you try this, is you will be the fool (Motley or otherwise) who buys the hyped stocks when they are high and dumps them when they are low.   As I noted in The Marketplace is a Battlefield you may think you are leading a surprise attack on the enemy, but instead are walking into a carefully laid ambush.

The pitfalls of investing are not "secrets" or hidden in any way.  The experience of the dot com era is there for everyone to see - but few choose to remember it.  The experience of the 1989 Real Estate bubble were there for everyone to see, but few thought about it in 2007 and 2008.

Are we headed for another "dot com" style bubble?  Perhaps - people are desperate to invest these days, and being "behind in their game" are desperately latching onto whatever "sure thing" seems to be coming along.

This is tragic, because this time around, the Baby Boomer generation will have no fallback to rely on.  They will be near retirement age and have lost it all on ZipCar - or whatever the next Pets.com is this time around...