Sunday, 29 May 2011

What to do when everything is overpriced?

 

It’s a difficult challenge isn’t it? And no matter who you are and how much money you have to invest, you will run into this situation at some point. Last week, Microsoft (MSFT) announced it was purchasing Skype for $8.5 billion in cash, an aggressive move for the usually conservative Redmond based company. Why? Because by most measures, Microsoft paid a hefty price to purchase Skype. Few have doubts about the possible synergy between Microsoft and Skype or even the Internet phone business that Skype dominates. The entire criticism was based off of one thing; buying an overpriced asset.

Easier To Say Than Do

I would however caution critics to look at the problem that Microsoft was faced with. What do you if you have tons of cash, need to generate new business but all deals and possible deals that are being made are being done at expensive, inflated prices? The answer here would obviously be to wait. But for how long? What if you’ve been waiting for a few years now while Google, Apple, Facebook and others continue grabbing assets at increasingly inflated prices? Do you stand on the sidelines? If Microsoft had not purchased Skype, I am convinced that someone else would have paid that price. It can become very challenging to wait. Why? Because at some point, you start to doubt that the deals are actually overpriced. Maybe I’m missing something?

Same Applies To All Bubbles

When house prices, tech stock prices or any other bubble prices kept increasing, many had doubts that the valuations appeared to be exaggerated. Many waited for weeks, months and sometimes even years. At some point however, they often did give up and lost patience.In most cases, they got the worst of both worlds. They got in late so paid a high price but also ended up enduring the most losses. It’s not an easy problem, it really isn’t.

Buffet Approach

I rememebr reading Warren Buffet discussing the insurance indsutry which has a similar problem at times. If competitors are charging premiums that are so little that you consider that matching or beating those prices will end up costing you, what can you do? The choice is either to write some at a loss (although you can always hope that the math was incorrect) or to not do any new business. Buffet has always said he would much prefer the 2nd option which has meant that some of his insurance units got basically no new business for years at a time when pricing became too aggressive. It’s an approach that is much easier said than done of course.

What About You?

I’d love to hear your thoughts on this. Do you blame an executive like Steve Ballmer for possibly overpaying if that was the only way he could use Microsoft’s huge cash reserves? What would you do if you were about to buy a house but had a gut feeling that was supported by the numbers that prices were overinflated. Would you wait? Could you wait 5 or even 10 years?

http://www.intelligentspeculator.net/investment-talking/what-to-do-when-everything-is-overpriced/


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