An Initial Public Offering is basically a process when a privately-owned business faces the truth and goes to the market with the objective of winning the investors’ trust. During an IPO, shares are offered to a wide group of investors, which enables the business to gain the necessary capital for further growth. Shareholders, on the other hand, will ensure their share in the company management decisions, in its profits, its remaining balance and participate in the evaluation of its stock. History remembers multiple successful IPOs. For example, the automotive plant General Motors; or Visa, the provider of electronic payments; Facebook, the social network; or Alphabet, the tech giant. On the other hand, the IPO market has also seen several miscalculations, when the companies entering the market did not convince investors.
Favourable conditions for an IPO
In recent years, the market with IPOs has been expanding, particularly in the USA, where 160 companies entered the stock exchange only in the last year. Companies are taking advantage of the suitable economic environment and the healthy conditions of the global economy combined with the bullish sentiment in the stock markets. The first six months of this year suggest that this year will be even more successful in terms of the number and size of IPOs. The value of the companies entering the stock market in the USA has climbed to $35 billion, representing the best half-year since 2014, which is also appreciated by the stock markets.
While the stock index of the 500 largest American companies, the S&P 500, has enjoyed growth of almost 2%, shares of companies with HQ in the USA that entered the stock exchange have recently strengthened their position (according to the data by Renaissance Capital – an investment banking player focusing on IPO) by 25% on average. Stocks of technological companies have been faring the best, as they have grown by 50% on average. This category also includes Dropbox, the cloud services provider (+54%), or Spotify, the music and streaming provider (+27%). More than 80% of these technological IPOs are currently traded above the initial price. Eight out of the ten best-performing IPOs of 2018 in the USA have increased their value by more than 100%.
The stock exchange does not guarantee profits
However, the league chart of the performance of this year’s IPOs in the USA also has its bottom end. The lower rungs of the ladder are occupied by companies whose stock declined between 30 to 50%, as entering the stock exchange is no guarantee of prosperity in and of itself. Profits mainly depend on the business model, competitive edge, the ability to expand and increase the margins and business progress over the long-term. And these are the categories that an IPO as such will not address.
An example of an unsuccessful IPO can be illustrated with Snap, the provider of Snapchat, the well-known social media app. After the initial party, the hangover came rather soon. After a sharp increase, the company stock declined as a result of unsatisfactory economic results. In total, it fell by more than 20% since the IPO in the spring of 2017. On the other hand, Tesla, the e-cars manufacturer, has not been able to generate a profit even eight years after the IPO and keeps subsidizing its manufacturing from other sources. Despite the above, its stock is traded close to the record maximum thanks to the Silicon Valley status it carries with it.
However, even Amazon did not initially do very well, even in the long-term. The tech giant entered the stock exchange back in 1997. Until the last part of 2001, it had not reported a single profitable quarter and up to 2003 not a single profitable year as a whole. Still, after more than twenty years, the stock climbed from the initial price of $18 to the current $1,700 per share, making the increase in price exceed the incredible level of 9,000%! At the moment, the market value of the giant led by Jeff Bezos is $830 billion, ranking the company in the third position in the S&P stock market index, right after Apple and Microsoft. So how does one orientate on this market?
IPO through index funds
A more efficient method than cherry-picking in the IPO market is investing through index funds (ETF). The market offers several ETFs focusing on IPOs. For example, the First Trust US Equity Opportunities index fund, which successfully passed the test of Across’ strict criteria and is now listed on the Créme de la Créme (containing the selection of the best index funds of Slovak investors). Since the introduction to the market in April 2006, it has risen by more than 7% p.a. including the dividends. Throughout the whole period, until the end of June this year, it outperformed the index fund focusing on the 500 largest US companies by more than 130%.
This index fund includes approximately 85% of the market capitalisation of the IPO market with medium-sized and large US businesses that have entered the stock exchange in the past four years; it is traded in US dollars and pays a quarterly dividend. It meets all the requirements in terms of costs, liquidity, fund size and the ability to copy the underlying index with maximum precision. It is automatically rebalanced on a quarterly basis and copies the performance of 100 companies with dominant proportion of tech sector businesses, which include e.g. PayPal Holdings, Kraft Heinz, AbbVie or Twitter.
Giants heading to the stock exchange
Some large global players have announced their plans for an IPO in the upcoming months, including Saudi Aramco, the crude oil giant; Xiaomi, the Chinese manufacturer of mobile devices; Uber, offering alternative taxi services; or Airbnb, an online provider of tourist accommodation. Also, global computer manufacturer Dell has announced its return to the stock exchange after 5 years. These businesses will certainly be under investors’ scrutiny and are expected to offer attractive earnings. Which investment option are you going to leverage in the upcoming months?