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Giddy 2017 — But Be Mindful of 2018’s IPOs?

Stocks have had a high profile run for 2017, and some are expecting a new crop of IPOs to fare well in 2018 amid continued giddiness. Mind the margins and the multiples, however.

Amid the bull run that runs, still bullishly, what to do for an encore?

The major U.S. equity indices have been on a tear by any stretch of the imagination — and what remains stretched, too, are valuations.

And right on the cusp of a new year, where marquee names in tech such as Spotify and Airbnb and Lyft, as Reuters reports, are planning to hold initial public offerings, the sustainability of investor enthusiasm and those stretched valuations might well be considered, perhaps to give pause before what might be a stock market pause.

With just a few sessions left in the year, the S&P is up more than 19 percent — and the tech-heavy NASDAQ is up 29 percent.  The rising tide was enough to lift just about all boats, and that included the listing ship of the IPO market, which had, at least in terms of headlines, been dominated by the likes of Snap and Blue Apron, IPOs famously busted and trading well below their offer prices.  IPOs gained some ground in the second half of the year, and Reuters noted Nelson Griggs, president of the NASDAQ Stock Exchange, as stating that “with the market at all-time highs, valuations are at the high end, presenting a favorable backdrop for IPOs,” and further going on to say that “interest rates are still around historical lows, so there is likely a sense of urgency for companies to take advantage of the window.”

At the end of the year the tally could be, actually, pretty decent for IPOs, where a total of 159 companies will have come public in 2017, and where the total raised, according to the newswire, stands at about $38 billion — which is a far cry from the $93 billion zenith in 2014 seen in the wake of the financial crisis that hit earlier in the millennium.  But the 2017 numbers also compare favorably to the 106 IPOs seen last year.

Yet the statements by Griggs presage what might be tough hurdles to, well, hurdle, and recent events in the IPO realm give a few signs that the game must be played perfectly if shares are to run sustainably right out of the gate, regardless of the company doing the listing.

Consider online styling service Stitch Fix, whose shares were off more than 10 percent on Wednesday after its first report as a publicly traded company a day earlier (and roughly a month since its IPO). The company beat estimates by a penny, and sales edged the Street by a million dollars at $296 million, but it was the margin outlook that spooked investors.  The stock had run about 60 percent higher in the weeks since its debut, and the stage was likely set for disappointment, here in the form of margin guidance.  Management said on the conference call that “higher shrink” hit inventory (shrink is tied to theft from employees or customers or damage in transit) hit margins.

That may be company-specific, but the some of the refrain is familiar, as investments in growth initiatives (in this case, men’s and plus sized apparel), which ding margins, have also been the hallmark of many tech firms.

Against that backdrop, margins may get renewed focus as companies come to market next year and beyond.  That’s because what falls out of margins are earnings (or losses), and earnings help drive valuations.  One reason companies may want to get into the public sphere now is that since interest rates are on the rise (amid Fed boosts and as growth expectations have been ratcheted up), raising capital privately may not be as easy as once it was because investors demand incrementally higher returns.  But by going to market, perhaps they can tap into the excitement that is already palpable.

Ah, but the valuations.  At 26x trailing earnings (and 21x forward estimates) for the NASDAQ, as calculated by The Wall Street Journal, there is precious little room for error on the E(arnings).  The busted IPOs of the past several months — names such as the aforementioned Snap and Blue Apron, among others — show that results do matter, even more, eventually than promise.

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