There's an old joke about a restaurant called the Karma Cafe. They have no menus; each customer simply gets what they deserve.
Well, investors who owned identity-protection firm LifeLock (LOCK) may have gotten what they deserved on Tuesday, when their shares plummeted by nearly 50% in a single day:
The trigger for the sell-off was the announcement of a Federal Trade Commission lawsuit over the firm's alleged noncompliance with a 2010 settlement concerning false advertising.
LOCK's plunge was thus due to a mixture of old news and a new twist. But the real question was why anybody would want to own LifeLock -- which recently traded as high as $19.15 -- in the first place.
LifeLock is emblematic of the insanity surrounding many IPOs that were brought to the market in recent years.
The company earned just $0.09 a share in 2012 but debuted at $9 -- a P/E of 100. When 2013's EPS grew to 15 cents and were announced in 2014, idiotic traders pushed the shares up to $22.85, or 152x trailing profits.
Revenues continued to ramp up during 2014, yet earnings dropped by 80% to just 3 cents a share:
Then, this year's first quarter saw LifeLock's highest sales ever -- but LOCK nonetheless reported its largest three-month loss in its short history as a public company. Unless you're Amazon (AMZN), that should have been an enormous red flag (and even Amazon's history is quite controversial).
Now the question is why in the world would anybody believe Morningstar's forward P/E projection of 9.1x (following Tuesday's drop)?
You should also note that Value Line was only looking for LOCK to report 42 cents EPS in 2015 and 68 cents next year before LifeLock's very significant legal problems became public:
I'm skeptical that the company's actual results will be anywhere near even analysts' now-lowered projections. In fact, I think LOCK is probably best sold even in the $8 to $9 range.
Of course, LifeLock is far from the only crazy game on Wall Street.
Arts-and-crafts retailer Etsy (ETSY) has never made any money and warned that it won't do so any time soon, but the company still managed to price its IPO at $16 in April. Hyped-up traders paid as much as $35.74 soon afterwards, only to see their shares fall to $12.80 in less than two months:
ETSY has managed to rebound from that low by almost 50%, which tends to keep short-term traders interested. But as with LifeLock, the problem is that owning crappy companies is like playing musical chairs -- the music can stop at any time without notice, leaving massive losses for players.
My advice is to always fight "FOMO" -- the "Fear Of Missing Out." The best way to avoid losses from absurd trading is to simply refuse to play the game.
Paul Price is a regular contributor to Real Money Pro. Click here to learn about this dynamic market information service for active traders.