As IPOs Rise, Red Ink Fails To Deter Investors

You know the acronym.

IPO. Stands for Initial Public Offering.

Or maybe it could stand for “It’s Profitable…Or not.”

It doesn’t seem to matter, at least on Wall Street these days.

As The Wall Street Journal reported on Tuesday (Oct. 2), as far as new issues on the public markets go, it may matter not that the red ink is piling up.

The stats may be a bit sobering. Consider the fact that as the Journal cites University of Florida Professor Jay Ritter, roughly 83 percent of IPOs through 2018 to date have been with firms that have lost money through the year that predated their IPOs. That percentage marks the highest tally in 38 years. The previous peak was 2000, which showed that 81 percent of firms that came to market that year had lost money.

And, of course, the year 2000 stands out as a landmark annum for stock market frothiness. From dot com to … kingdom come, in short order.

History may not repeat itself, but then again, there are echoes in this chamber. The Journal article quotes any number of industry observers ringing cautionary bells. Don’t chase what’s being chased, to paraphrase one CIO quoted in the article. Ritter’s own data shows that within the tech space, where a scant 14 percent of companies that came public way back in 2000 had earnings, that percentage is about 19 percent. We’d note that is a bit … healthier – but hardly robust.

With risk comes reward, as the returns have been a bit healthier as well. The average return of profitless IPOs was 36 percent through last week, said the Journal, better than the 32 percent for those with profits.

A poster child here is SurveyMonkey, which does not actually go out with questions and note primates’ preferences. The parent firm, SVMK, has never turned a profit. Yet the stock leapt 40 percent in the wake of its IPO last week – because there is cash flow. Indeed, sometimes earnings can be negative while a company generates cash flow, and SVMK stands out as a breed apart.

But in a glaring example of hope over money-making, a biotech, Solid Biosciences, hasn’t seen top lines materialize yet (if you don’t have a top line, can you even say there’s a bottom?), and yet the stock has roughly tripled since its own IPO, stated the Journal.

So the question is … why? The Journal speculates that there is hunger for IPOs simply because a lot of firms are opting to stay private, so investors clamor for what’s on offer. We wonder if it might be the case that some of that enthusiasm may be siphoned off if Uber and/or Lyft come to market early next year, as has been speculated in publications such as Financial Times.

Of course, there’s always the fear of missing out – and in markets, there are always rotations. Might there be a rotation even among IPO investors, selling gains and moving funds into the next hot prospect or prospects? Might there be even another rotation that pushes IPOs even higher – say, if investors continue to get out of cryptos and into IPOs? We’re speculating here, but speculating about speculation is relatively safe unless you’ve got skin in the game. And while we are on the subject of profitless companies, the price to sales ratio of the tech-heavy NASDAQ is at about 3.5x, just under multi-year peaks (where it had been 3.9x).

If they’re not careful, the red ink may spill onto investors’ own profit and loss statements.