I had a discussion with a friend the other day regarding investments and the topic of (Initial Public Offering) IPO’s surfaced. He had been trying to convince me that this new IPO that just came out is a fantastic opportunity and he thought I should get on board. My stance on IPO’s has always been, and always will be the same: just don’t do it.
In a nutshell, an IPO is a company that is making the transition from private industry to the public sector. The IPO is generally looking to expand their business through public support and will hire an underwriter to evaluate the company in order to establish the type, price and amount of shares to be issued to the public.
This process can be quite complicated, but here is how I generally see it:
Company A wants to expand so they go through the IPO process. They establish their market cap and offer a number of shares at an established price. Sounds reasonable so far huh? This is where it gets tricky. The IPO price is rarely the price offered to you and I, the average investor. Often only investors that are able to get in on the initial public offering price are large institutions such as mutual funds and large brokers. When the offering eventually comes down to the little guy (you and me) it is often well above the established IPO price.
When the average investor is able to buy into the IPO, they usually must do so when it hits the market and is available for trading for everyone, the big guys already got their slice of the pie. The real kicker in my opinion is what happens over the next several months. After the IPO has been publicly traded for 6 months, the big name players (initial investors, insiders, etc) are now allowed to sell their existing shares, which often creates a sell off and drops the price of the stock significantly.
Let’s look at a recent example of an IPO. This IPO opened at $27 a share. And is now $22 a share after only 3 days. The real IPO investors got in for around $17 or so. So then, where does this leave us? The average guy has already seen an 18% drop in the initial offering. The big guy has seen a roughly the same percentage, albeit in the black because they got in at a significantly lower price via the real IPO pricing.
So now lets actually take a look at the fundamentals of this new IPO. Currently this IPO is showing negative earnings, and will do so at least for the foreseeable future. In fact, a major administrator in this company has said that they can’t say if this company will ever show profitable earnings. What?!?!?
OK lets continue, this IPO currently shows a Price to Sales (PS) of 68 and a Price to Book (PB) of 18. Earnings, growth, ROE, ROA, ROI are all in the negative digits. This company has NEVER made any money.
I know what you are saying, this is some little rinky dink company that has a microscopic market value and I am using it to skew the data and make my point right? Wrong. The market cap was evaluated at 33 billion dollars when it entered public trading. After roughly 3 days of trading, the largest cap is around 20 billion.
At an evaluation of 33 billion dollars, this IPO is bigger than Lockheed Martin, Morgan Stanley, Colgate, Netflix, GM, Ford and Kraft-Heinz, just to name a few. It is twice as large as Boston Scientific, Exelon, Activision, Deere, Target and Allstate. How can I possibly consider this evaluation anything other than a joke considering a new company, with no earnings and such poor evaluations has a higher market cap than Ford, GM, Deere, Lockheed Martin and Morgan Stanley?
What is the name of this IPO you ask? Snap Inc. (SNAP). That’s right, snapchat has an evaluation higher than all of these companies and sits roughly in the top 1/3 largest companies traded in the US, hasn’t made a dime, and may never do so.
In six months there will be a lot of average Joe’s like you and I sitting back, scratching their heads and saying “Where did my money go?” I’ll tell you, right into the pockets of the management of Snap and the initial investors. Don’t get me wrong, I doubt Snap will fall below the $17 entry price that the big guys had access to, they will simply throw more money into it thus supporting it until the big sell off later down the road.
Well the Snap enthusiast may argue that “Apple, Amazon and Facebook were IPOs once and look what happened to them? You would be rich if you got in when they first started.” This is true, but there have been a lot of people who significantly increased the value of their portfolio, and continue to do so today using these companies, with infinitely less risk. I’m interested to see where Snap will fall to in another year or so. If I am wrong I will certainly admit it, but this simply makes no sense to me.
“You can never hit the game winning home run in the bottom of the 9th inning to win the World Series if you never get up to the plate.” This is true, but the ball boy (average investor) will never have the opportunity to take the swing. We have to work hard, save and invest wisely and not swing for the fences. Consistent dedicated investing is the way to grow wealth for the Average Joe, otherwise you might have better luck with lottery tickets.