Motley Fool: Signs indicate Groupon’s rise may not last

Initial public offerings (IPOs) can be exciting, and Groupon’s (Nasdaq: GRPN) recent debut certainly attracted a lot of attention. Is the stock a good buy? Opinions differ at Fool HQ, but the case against it is strong. For example:

It faces daunting rivals and potential competition, from the likes of LivingSocial (backed by Amazon.com), Google and others. There aren’t many barriers to entry, either, so new competition can crop up suddenly. Its future is very uncertain, unlike more predictable businesses.

Its business doesn’t inspire great customer loyalty. If you’re a coupon seeker, you’re not likely to stick solely with Groupon and ignore other options.

The founders appear to be cashing out: Of the last $130 million that was raised pre-IPO, $120 million went out the door to founders. We’d rather see these folks leaving most of their stake intact, aligning their interests with shareholders.

Its accounting has raised eyebrows. The company restated its revenue recently, and has changed how it defines certain expenses.

Hot IPOs tend to cool off. Per Bloomberg Businessweek, 20 of the 25 “hottest” IPOs of 2010 and 2011 have fallen sharply.

And finally, it’s not yet turning a profit. Why take a chance on it, when there are lots of undervalued and proven companies around? (The Motley Fool owns shares of Google, and Google and Amazon.com have been recommendations in our newsletters.)

Ask the Fool

Q: I see that Groupon just went public, raising $700 million. But I also see that its market capitalization is above $7 billion. How can that be? – G.D., Franklin, Tenn.

A: The key number to note is 6.3 percent. That’s the portion of itself that Groupon issued in stock to the public. Its insiders control the remaining shares. The company issued 35 million shares in its initial public offering (IPO), but there are more than 550 million shares in existence.

When you multiply all the existing shares of the company (those trading on the public market and those that are not) by the current stock price, you get its market cap, which was recently more than $10 billion.

Q: What does it mean when a company has “initiated coverage” on a particular stock? – T.L., Detroit

A: Big brokerages and investment banks typically employ analysts to follow and study various companies. The analysts issue recommendations that are passed on to clients and others.

When a brokerage initiates coverage of a company, it just means that the company is now being followed by the firm and that the brokerage has an opinion on it (perhaps “Buy,” “Hold” or “Sell”). There may also be a detailed research report available on the stock, which is typically much more illuminating than a simple one-word rating.

“Sell” ratings have long been relatively rare. That’s because since these ratings usually come from organizations with investment banking operations, the organizations haven’t wanted to burn any bridges with current or potential investment banking clients by being too negative.

My dumbest investment

One of my dumbest investments was in Bradley Pharmaceuticals. The big problem was that I didn’t understand the nature of the business. It was one of my earliest forays into investing, and the pharmaceutical/life sciences/medical area was not one I was sufficiently familiar with. When it fell, I sold.

I learned to write down the reasons why a company is attractive, read up all about it and its industry, and read the 10-K report, too – at least the “Management Discussion & Analysis” section. – Felix E., Singapore

The Fool responds: It’s a common mistake to invest in what we don’t understand – just think back to Enron. And biotechnology enterprises can be extra-risky. Not only is it good to understand the science behind the treatments being developed, but you also need a good handle on competing treatments that exist or are in pipelines.

Many biotechs aren’t very profitable yet, either, with investors pinning much hope on drugs that may or may not get FDA approval. Before buying, be sure you understand exactly how a company makes its money and how reliable its future growth is.