IPO Market Heating Up, but That Doesn’t Always Mean Things are Great

The initial public offering (IPO) market for 2019 was expected to be a big one—both in terms of the quantity and the quality. The government shutdown slowed the IPO market down in January and February, but things are starting to heat up and there are several IPOs set to price in the coming days that have investors excited. Pinterest, Zoom Video Communications, and Greenlane Holdings are all expected to price this week, and Uber is expected to go public in May.

The biggest IPO so far in 2019 has been Lyft (Nasdaq: LYFT), the ride-sharing rival of Uber. The stock started trading on March 29 at $87.24 per share, and it has since fallen sharply and closed at $56.11 on April 15.

Seeing an IPO fall after its first day of trading isn’t something new, and it also isn’t a bad sign for the company to rebound after the initial excitement dies down. When Facebook (Nasdaq: FB) went public in May ’12 it fell from an initial price of $42.05 to below $26 in the first 10 days of trading. It would eventually fall to as low as $17.55 in September ’12.

From that low in 2012, the stock would rally tremendously over the next six years and would eclipse $200 a share last July. Investors that were patient with Facebook got paid off in a big way. Those investors that were expecting to get paid off in a big way within the first few months of Facebook’s debut were likely disappointed and sold way too early.

Investing in IPOs isn’t a guaranteed success and it isn’t for the faint of heart. In the first three quarters of 2018, the vast majority of companies that debuted were not yet profitable. According to an article from the Wall Street Journal from last October, 83% of IPOs were on companies that lost money in the year ahead of the IPO.

“About 83% of U.S.-listed initial public offerings in 2018’s first three quarters involve companies that lost money in the 12 months leading up to their debut, according to data compiled by University of Florida finance professor Jay Ritter. That is the highest proportion on record, according to Mr. Ritter, an IPO expert whose data goes back to 1980.”

In addition to the risk of investing in individual IPOs, there could also be a certain risk factor to the number of IPOs being a bad sign for the overall market. The chart below from TopDownCharts.com shows how the IPO market has been trending lower since the tech boom of the late 90’s. We saw a spike from 2004-2007, but the number of IPOs dropped sharply during the financial crisis.

The number of IPOs in 2017 was 160, and that figure jumped to 191 in 2018. And I am only talking about U.S. IPOs here. Many analysts believe 2019 could produce more IPOs than we had in 2018 and that could be a sign of concern.

A recent article from CNBC suggested that companies were rushing to go public while the economy was still in good shape and investors still had an appetite for risk. This was the opening sentence of that article:

Billion-dollar private companies are stampeding to go public this spring. But fear, not excitement, may be driving the herd.

The drop in stocks in the fourth quarter likely cost some companies a bigger payoff on their IPO than if the company had gone public earlier in 2018. Now, with investors seemingly pulling back the reins on their risk appetite, some companies are scrambling to go public before the next bear market or the next recession.

The bottom line is that IPO investing isn’t for everyone. There is no guarantee that the stock will move higher after its debut and the attraction to the stock is usually based on potential, not current performance.

About Rick Pendergraft

Rick has been studying, trading, analyzing and writing about the investment markets for over 30 years. He has worked for some of the largest financial publishers in the world and he has been quoted in the Wall Street Journal, USA Today, the New York Times and the Washington Post. In addition, he has been interviewed on Bloomberg, CNBC and Fox Business News. Rick’s analysis process includes fundamental, sentiment and technical analysis. Rick started college as an education major, wanting to teach economics, but eventually changed to majoring in Economics and received a Bachelor of Science in Economics from Wright State University. His desire to inform and educate people is at the heart of his writing.

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