Investing

The Bad Nutrition of IPOs in 2019

By John Del Vecchio  |  September 10, 2019

The market for initial public offerings is still on fire. And, as I’ve warned in prior issues of The Rich Investor, a hot IPO market is usually a sign of a market top.

Money-losing companies with nosebleed valuations don’t go public in depressed markets. No, no, no… Instead, insiders are eager to cash out when the going is good.

And, boy, do these companies ever lose lots of money today — billions upon billions of dollars. Even after we’ve seen the first trillion-dollar market cap, a billion dollars still is a lot of money.

Speculators have piled in too and the mainstream media has been all over IPOs in 2019. In terms of actual results, it’s a mixed bag.

One exchange-traded fund (ETF) that tracks the IPO market is up 33% this year. “Winners” include Beyond Meat (Nasdaq: BYND), which enjoyed a zeitgeist-driven up-move.

There are multiple high-profile clunkers too, including Uber (NYSE: UBER) and Lyft (Nasdaq: LFYT). Both ride-hailing services/apps have seen their stock prices deflate.

That’s more representative of recent experience for IPO investors. Many of them have gotten burned.

A Closer Look at Those Next Big IPOs

Consider Beyond Meat, which announced a secondary offering shortly after its IPO. BYND got scorched — overcooked beyond “well done,” if you will. It’s a clear red flag that management’s seeking more capital so soon after going public. It doesn’t add up.

Pinterest (NYSE: PINS) has seen its stock rally only for the bubble to pop a bit. At $29, most investors are sitting on a loser.

The next big IPO thing is WeWork. WeWork provides shared office space for startups and entrepreneurs.

Already, however, investors are getting nervous. WeWork is likely to reduce its valuation to attract more interest. At $20 billion, interest is thin. The fact that bankers and insiders are huddling shows this is more a marketing scheme than a capital-raising exercise.

It’s a cash-out scheme, not a plan to fund a going concern.

By the way, that $20 billion figure is down from nearly $50 billion as of the last round of venture funding. In other words, investors have already been hosed, and this thing isn’t even public yet.

That’s why I wouldn’t touch most of these concepts with counterfeit money.

The exception might be Beyond Meat — but at much lower prices. The secondary offering scares me away big time. Food companies with heady growth will make for solid acquisition targets. The risk-reward proposition is better if BYND takes a dive first.

If you’re going to dip your toe into the IPO market, take some advice from Goldman Sachs (NYSE: GS). Now, I hardly ever suggest you pay attention to what Goldman Sachs recommends. The old vampire squid has a reputation for looking after itself, ahead of even its best clients, doing stuff like, you know, like trading against account holders’ positions to pad their own profit statement.

Look, some things never change on Wall Street. But Goldman did recently offer a useful analysis of the IPO market — 4,418 of them spanning 25 years, to be precise. And it came up with some common factors that separate the winners from the losers in this corner of the market.

Some Things to Consider…

Age is just a number. By itself, the age of a company is not predictive of its performance three years after an IPO. However, younger firms have higher growth rates.

No duh. They’re working off a smaller base. Companies less than five years old typically have higher growth rates. Smaller companies are working off a lower revenues base. Older companies, like 15 years or more, have already experienced their growth spurt.

It’s just what you would expect. That leads to factor number two…

Sales growth is a predictor of performance.

However, age doesn’t predict IPO performance. Therefore, don’t get caught up in huge growth rates. This is especially true if the third factor is in another world…

Valuation is factor No. 3. Goldman found that valuations are high just prior to a recession. Does that ring a bell? Today’s IPO market valuations are insane. Heed the warning.

The fourth thing to consider is a path to profitability. This is where you should focus attention on analyzing these companies. Companies that are profitable two or three years after the IPO perform best.

Unfortunately, I fear many of the stocks in this crop of IPOS may never be profitable.

Last, but not least, is the sector the company operates in. In the late 1990s, during the last IPO boom, the place to be was information technology. More recently, healthcare has been hot based on the offerings of biotechnology firms. But what the hell is “Beyond Meat,” anyway?

Mostly, I don’t think “sector” matters much today. The path to profitability in the context of rapid growth is what matters.

Focus your attention there and you might have a chance. Don’t get caught up in the glossy sales story.

In the end, what you pay is what matters most.

A Worthy IPO

Of course, not all IPOs are over-priced.

One of the recommendations in the September issue of Hidden Profits is a recent IPO.

Unlike the other clunkers to come public though, this one has a very valuable asset hidden in plain sight. There’s no guesswork either. It’s very easy to know what that asset is worth. And as a result, this IPO is mispriced. In two years, the gain could be 50-100%, if not more.

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John Del Vecchio

John Del Vecchio is the author of the bestselling book, Rule of 72: Compound Your Money and Uncover Hidden Stock Profits and What’s Behind The Numbers: A Guide To Exposing Financial Chicanery And Avoiding Huge Losses In Your Portfolio.

As the in-house stock market guru and forensic accountant for Dent Research, John stood on the shoulders of the great David Tice, James O’Shaughnessy and Dr. Howard Schilit, and built a framework of algorithms and a multi-factor grading system that has made him one of the more successful short-sellers around.

John is also the executive editor of our Hidden Profits newsletter and our trading service Small Cap All-Stars.

He graduated Summa Cum Laude from Bryant College with a B.S. in Finance and was awarded Beta Gamma Sigma honors. He earned the right to use the Chartered Financial Analyst designation in September 2001.MORE FROM AUTHOR