Questions, Questions, Questions

Hey, Everyone! The Annotated Bibliographies are FINALLY done!!!!! Now its time to talk about research questions, and justifying them.

I narrowed down my research question a bit more from the outline from last week. Basically, I'm asking: Post IPO, which comparable firm multiples are most effective in valuing Social Media Firms on the Solactive Social Media Index, and does the Price-Earnings Effect still hold in this market?

Scope: I have narrowed my scope in multiple ways. The first means in which I have narrowed my scope is by looking specifically towards the Social Media Market, and social media firms following their IPOs, when they are first traded publicly. Since I can't look at every Social Media firm that has ever been traded on the stock market, since I would have no means for choosing firms, and because of the large number of them, I am looking towards the firms on the Solactive Social Media Index, which is essentially measures the value of Social Media stocks. This index, as according to one of my sources, is largely considered the most extensive and appropriate means of looking at Social Media firms. Ultimately, this specification allows me to spend more time researching the significant aspect of my area of inquiry since I do not have to spend time worrying about which Social Media Firms to look towards. The next specification in my scope is looking towards specific valuation models and stock market effects associated with it. I specifically look towards comparable firm multiples, which are essentially ways of assigning worth to a company relative to similar companies in the industry. Looking at this model and the Price-to-Earnings Effect gives my research more specificity, but also allows me flexibility in choosing models. The ambiguity of the "comparable firm models" is intentional since I cannot, right now, project how many models I will look at. This allows me to experiment with only a few or many models, depending on how long my research actually takes. Finally, the Price-Earnings Effect is used to act as an interesting and important addition, since the effect is fundamental in finance and deserves to be studied. Furthermore, there might be an instance in which the comparable models produce no significant information whatsoever, as one of my sources implies might be the case, so this source provides an extra outlet for my research.

Key Terms: I have quite a few key terms in my definition, all of which will be defined as they naturally appear in the literature review. The definitions that I use and discuss are commonplace in academic journals, so I can justify the validity of the definition through various professors that write about them. The first key term is IPO. This just stands for Initial Public Offering, and is just when a company first sells it stocks to the public, and begins to appear on the stock market. Thus post IPO is looking at the time after a firm goes public. The next key term is comparable firm multiples. As explained previously, in finance firms are valued to assess their worth using models. A Comparable firm multiple is a number associated with some aspect of a companies financial situation that is compared with numbers of the same multiple from other similar firms in the industry to see whether the company in question is worth more or less relative to the other firms analyzed. A financial index is essentially a measurement of the value of a specific industry, or section of the stock market. It contains firms highly representative of the industry of the index. Finally, the Price-Earnings effect is a financial phenomenon, where firms with a low stock price to finance Earnings-per-share ratio perform better than firms with a higher value of the same ratio.

Because my research is testing to see whether certain fundamental financial phenomenon and measurements appear in the Social Media market, my question only assumes that the comparable firm multiple can be applied to Social media markets. Even this, however, is a loose assumption as if I find that the results are insignificant, the conclusion of my study will be that the multiples cannot be applied to the Social Media market. Essentially, because my research tests whether certain assumptions are true in the first place in the Social Media market, no aspect of the question should rest on unsound logic.

Variables: The primary variables in my question, which I can adjust, are the comparable firm multiples that I ultimately decide to use to test my research question. Foreseeably, I may slightly modify my question to analyze choice firms in the index, and in this case, specific Social Media firms in the index to analyze in my research question would also be variables.

Researchability: I envision myself looking at the past data of the Social Media firms on the index and performing calculations using the comparable firm multiples to predict the future price or other financial variable of the firm, and comparing it to the actual value at a certain date. After calculating residuals and percent errors, I would be able to determine which multiple would statistically perform the best in the market. Following this, I envision myself analyzing the firm, similar to other researchers I have read, with the Price-Earnings ratio to determine if the Price-Earnings effect still applies within the Social Media Market.

Gap: The gap in my research is twofold: one, according to one of my sources, Social Media firms and their IPOs are substantially different from other firms and IPOs, making them a particularly interesting and important subject to study. Second, and more importantly, the Social Media market has not been analyzed AT ALL in modern finance research, and due to the increased success of these firms as well as their unique qualities, as explained before, there is a natural gap to research whether fundamental questions, such as the best way to value a firm, apply and can be answered in the Social Media market. Essentially, there has only been one finance paper on Social Media firms, describing their characteristics and relative performance. My research, as I explained earlier, begins to test whether as analysts, we can make assumptions about the Social Media market like we do of other different industries.

Significance: Firstly, Social Media is growing in popularity and size, so it is already important to look at what makes a Social Media firm successful for a prospective modern investor. Taking a more nuanced approached, I am looking at Social Media IPOs, and determining whether early on, a multiple can value the firm accurately. In the modern day, IPOs are of increasing relevance due to the increasing number of startups wanting to perform IPOs to gain more funds. Thus, the research into Social Media IPOs gives insight into valuing young, growing IPOs in the modern world.


OMG. I'm so sorry for that SUPER LONG POST, but I had a lot to say. (1,113)

Akash

Toeing the Outline

Another drama filled week has come and gone, and I'm starting to look at even more specific sources for my research study. The big drama in the coming week is if i'm ever going to be able to decipher a research paper that is super useful to my methodology, but super esoteric for me right now.

Anyways, as annotated bibliographies are due in the coming week, and the ever present literature review makes itself moe prominent, it's time to create an outline for the literature review. If you didn't remember, my subtopics were (change a bit since I shifted my topic a little): Industry Analysis, Valuation Technique Analysis, Comparable Firm Multiple Application.

Subtopic 1: Industry Analysis
The basic premise of Finance, and analyzing the stock market is to be able to determine how a firm is performing, and in turn, whether to invest in it. It is essential to first narrow down the focus of the literature review to a specific industry sector of finance, or a specific type of event in finance, since if we looked more generally at every industry, we often wouldn't be able to draw conclusions based on the incredibly diverse nature of different institutions and sectors.

• Batov et. al shows the vast differences in how Internet and Non-internet firms work. When looking at the value of non-internet versus internet firms, it appears as though non-financial variables play a much larger role in determining the value change of an internet firm as opposed to a non internet firm

Premise 1: There is an increase in personal startups throughout the country

Premise 1--> Conclusion 1: An increase in succesful companies can be expected within the future

Premise 2: Succesful companies want to become more profitable

Premise 3: To become more profitable, an increase in capital funding is needed

Premise 4: IPOs provide capital funding for companies

• IPO: Initial Public Offering is when a company first offers its shares to the public, and allows itself to be traded publicly on the market, allowing the company to gain capital when shares are first bought for the company

Conclusion 1+Premise 2,3,4-->Conclusion 2: IPOs are bound to increase and become more important in the future. They are relevant.

Counterargument: Private equity funding for startups is also an option, and also avoids litigation that IPOs have to go through. This could also be popular

• Even if is popular, it is difficult to study this, as private equity funding means that companies are not required to release financial statements, etc... Even if were to increase, would be of no use to us

Premise 5: Many of these new startups will be tech-oriented startups

Premise 5+Conclusion 2--> Conclusion 3: Tech. IPOs are bound to increase in the future, and become more relevant to society. 

Premise 6: IPOs carry many anomalies associated with them

• Ritter and Rajan both note that IPOs are underpriced relative to their first day closing market price. Something which is odd, considering that underpricing the IPO causes a decrease in capital funds for the company issuing the IPO in the first place.
• Zheng and Ritter disagree that IPOs underperform after they have initially taken place. Zheng argues that after accounting for several financial variables, and comparing the IPOs to other growth matching firms, they did not appear to significantly underperform, as Ritter claimed they did (Ritter claims that their return on equity (total investment) is lower than other firms in the same industry).

Premise 7: The Causes of these anomalies, as well as their impact on the industry market for the IPO are debated even today

• Damodaran and Ritter have differing views of valuation models that can be used for IPOs valuation. Researchers Fama and French revised a previous model to a newer model in 2014 to include additional factors when valuing young companies, typical in IPOs.

Premise 6+7--> Conclusion 4: Research concerning IPOs is up till now incongruous.

Conclusion 3+4--> Conclusion 5: Tech IPOs are an interesting area to focus research on

*I need to find additional reasons for narrowing tech IPOs down to Social Media IPOs (perhaps the increased prevalence of them, as well as the additional anomalies that they possess over other internet/software IPOs in addition to the fact that they are not really researched at all).

Subtopic 2: Valuation Technique Analysis

After focusing on the section that I will analyze, I need to answer what I will do in that specific section. The principal question of finance is, as stated before, how much is a company worth, and is it worth investing in? In order to determine this, individuals attempt to value companies using different techniques, which I discuss here.

Premise 1: There are two different types of valuation techniques: Comparable and Intrinsic

• Definition: Comparable Firms Approach attempts to use certain financial variables, indicative of a companies performance, to compare a companies value to other values within the industry, and determine if a company is overpriced or underpriced relative to other companies witihn the industry
• Downsides (Damodaran): Does not determine if the company is an "absolute" good investment. Other companies in the industry could have inflated prices as well due to, as Rajan puts it "overoptimism"
• Definition: Intrinsic Valuation attempts to determine the "true worth" of a company through a multitude of methods, more objective than looking only at the specific industry the company is in
• Looks at financial variables such as risk, and the amount of expected cash to be received in the future (future cash flows). Will describe Discount Cash Flow Model: Where the amount of money expected in the future is "discounted" at an interest rate to a present value, which is the calculated present value of the stock.
• Drawbacks: Hard to determine the future value of a stock (Ritter)

Premise 2: When analyzing Growth firms, intrinsic valuation models tend to fail

• Growth Firm: A firm whose value is primarily placed on how much it will grow/ expand in the future
• Damodaran/ Ritter: Both authors, in their individual research papers argue that because growth firms do not have much historical data pertaining to their finances, it is difficult to predict what future cash flows could be

Counterarguments: Damodaran argues that comparable multiple firms have many of the same issues that intrinsic valuation models have, and that they rely on the same fundamental assumptions. This could be problematic since often growth firms don't have the same business plans, making comparison in cases with little comparable firms difficult and inefficient. Liu et. al also backs this up, finding that many of the dot-com companies had horrible valuations when using comparable multiple valuation methods

• My response does not have full sources yet, though I would suspect that I would find a source discussing how many Social Media IPOs are venture capital backed, and that they would not really issue an IPO unless they were already succesful, which would nullify any of the arguments made by Damodaran and Liu et. al because they apply to incredibly young firm in the first place.

Premise 1+2-->Conclusion 1: It is best to use a comparable firm approach to valuing Social Media IPOs.

Subtopic 3: Comparable Firm Multiple Application

Now that I have narrowed down the topic to valuing Social Media IPOs with a comparable firm approach, we need to find a specific focus with which to apply the multiples in order to arrive at a research question.

Premise 1: There are common anomalies associated with the Price/Earnings multiple outside of IPOs

• Anderson explains the fact that stocks with low multiples tend to overperform stocks with higher multiples over the long run. He suggests a method for recalculating Price/Earnings to strengthen this effect

Premise 2: This effect has not yet been researched in in the context of Social Media IPOs

Premise 1+2--> Gap 1: Does the price to Earnings effect take place in Social Media Firms following their IPOs?

Premise 3: There is disagreement over the best multiple in different industries

• Gray et. all and Dittman disagree over the most overall effective valuation method. Gray et. al claims it as Total Enterprise Value/ Earnings before taxes..., while Dittman claims it as the Price/Earnings Ratio.

Premise 4: The Price/Earnings Ratio is more effective in valuing IPOs using forecasted earnings rather than historical earnings

• Studies by Moonchul et. al and Liu Jing agree with this, and it is generally agreed upon in the industry

Premise 5: Neither valuations have been performed on Social Media IPOs

• Bring up how Social Media IPOs are different enough from normal IPOs to warrant an examination of this

Premise 3+4+5--> Gap 2: What is the most effective variation of a multiple to use when valuing Social Media IPOs, and does trailing earnings ever become more effective than forecasted earnings in valuing a Social Media Firm.

Research Question: Post IPO, which comparable firm multiples are most effective in valuing Social Media Firms, and which anomalies still hold in this market?

WHOOOOOOOAAAAAAH

THAT WAS LONG. Hope you're still with me! (1485)

Akash

Thigh Gaps don't matter, but Research Gaps do

Well, another week has passed, and the idea that I have for my research topic is definitely solidifying. In celebration of this (clearly amazing, awesome, unparalleled) achievement, I'm bringing in two homies from my sources to explain how my research is totally unique and dope.


Jay Ritter: Yo dawgs, my name is homie Jay Ritter, but you can call me Jay R. My partner Kim Moonchul and I did a 1999 study on valuing IPOs using standard comparable firm multiples, like Price to Earnings Ratio and Book to Market Ratio. Basically, we found that although the multiples didn't perform that well in general, using forecasted earnings to value IPOs was waaaaay better than using trailing earnings (historical data) to look at IPOs and attempt to determine their value. Our data looked at A LOT of Software IPOs and Non-Software IPOs, but we didn't really look at any Social Media IPOs because, Guess What? they never existed, so if you're gettin' what I'm puttin' down, and Social Media IPOs are actually different than Software IPOs in a more general way, it could be totally cool to see if the measures we used can be better applied or are generally worse.

Piotr Wisniewski: Yooooooo FAM!!!! I Gotchu!!!!! Guess what Mr. Ritter, the clearly gaping hole with your study in the context of several modern IPOs is answered. I did a really short research project in 2014 on Social Media IPOs and why some of them were successful and others weren't. But guess what???????  I also talked about some differences that Social Media IPOs have to normal IPOs. Social Media IPOs are valued sooooo much more pre-issue relative to their first day closing market price than other IPOs. This means that from the start, there's something different going on with investor sentiment and demand with Social Media firms. In the long run, it seems, like other IPOs, that Social Media firms tend to be overpriced, but unlike other firms, THEY ARE ACTUALLY BEATING THE MARKET. That means that traditional valuation measures for firms might be more effective and telltale of Social Media firms, just by the nature of how these companies invent. A question that could naturally arise out of this is: is forecasted earnings still more effective than trailing earnings? This would intuitively make more sense as these companies are primarily growth centric, but how does this actually play out. Also, if this is the case, at what point (if any) does valuation using trailing earnings become more even or more effective than valuation using forecasted earnings? This could be REALLY USEFUL, because this change seems to suggest a shift in the maturity of the Social Media firm, from primarily a growth firm to a more mature firm. THIS COULD BE HUUUUUUUGE.

That's where my topic and research area comes in: looking at Social Media IPOs and determining whether the valuations like Jay Ritters still work with Social Media IPOs. I came up with the last part of looking at if there is a point at which forecasted earnings become less of a value predictor than trailing earnings for Social Media Companies after watching a few lectures by an NYU professor (Aswath Damodaran) on corporate finance. This topic is getting more interesting by the day, and I really think I have an interesting, rich research area. (552)

Peace Out,

Akash

A Totally Lit Review

So another week has passed, and I have finally found my research topic. It is going be looking at assessing the effectiveness of comparable firm multiples in valuing Social Media IPOs. The good news is that all of the research that I have done before arriving at my final topic is still completely applicable.

After talking about the Literature Review in class on Friday, I felt soooo much better about what I needed to do: I needed to:

1. Prove that I wasn't any joe schmo in the field
2. Establish what has been done on different areas of my research area
3. Show how my research contributes and answers an essential gap in what has been already been done

Based on these goals and my findings prior to this post, I expect to begin my literature review with a general description of what an IPO is, the importance of an IPO to a firm, and the different stages before the initial offering of an IPO. From this last part, I will begin to introduce anomalies in the IPO process (such as underpricing), which will naturally lead me to discuss the general underperformance of IPO's in the long term, as this is an anomaly that often occurs after the public issuing of a firms stocks. Following this discussion about IPO anomalies, I will discuss whether these things have any explanations, or possible factors which can aid in our understanding of them. From there, I can introduce the concept of firm valuation, and how when we value a company, we connect things that we already know about the company to future expectations we have about the company. This naturally leads into a discussion of what valuation techniques have historically performed the best, and in which scenarios the techniques have not been thoroughly tested in. This would lead me to a discussion of IPOs, and more specifically looking at the Comparable Firm Approach for valuation. From here, I can justify why I need to specifically look at Social Media IPOs, and then begin to pose a research question and reveal a gap in this area.


One Source that is profoundly important in my literature review and my area of inquiry is a source by Piotr Wisniewski. The source discusses Social Media IPOs, assessing the viability of a Social Media firm to conduct an IPO. This source is fundamental to my area of research since it explains much of the uniqueness behind Social Media IPOs, compared to non-technology IPOs and internet, software IPOs as well. For instance, Wisniewski notes how many Social Media IPOs are relatively overpriced as compared to other IPOs in the same industry (something remarkably different due to the general trend of underpricing for IPOs). Additionally, Social Media stocks tend to be relatively overvalued compared to the market and industry average, but unlike most IPOs, also outperform the industry and market average. This provides key insight into the differences between Social Media IPOs as opposed to other IPOs and is essential in establishing the gap in the research for the literature review. As many other sources typically discuss the long-term outlook of underpriced IPOs, as well as the valuation of these IPOs, it will be incredibly fruitful to see if the effectiveness of valuation techniques changes when looking at IPOs that have radically different initial valuations and short-term performance as compared to other IPOs.

(624)

Signing off,

Akash