What Can Investors Learn From the Explosion of IPOs?

In August, a number of popular tech companies announced plans for their initial public offerings (IPO). This is exciting for many investors who are looking for more opportunities in the technology and healthcare sectors, but the volume and timing suggest that corporate management teams are anticipating a less favorable environment next year. That would have meaningful ramifications for the stock market, and it is not something bull market investors want to hear.

The appetite and opportunity for new tech names

Palantir, Airbnb, Ant Financial, DoorDash, Asana, Snowflake, JFrog, and Sumo Logic are among the big names going public. These come on the heels of several successful IPOs this summer, such as Warner Music Group, ZoomInfo, and BigCommerce.

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The number of publicly traded companies this year is roughly half the high seen in the late 1990s tech boom. Many of the 1990’s offerings promptly folded when the Dot-Com Bubble burst, such as the infamous Pets.com, which was liquidated in November 2000, less than ten months after it went public. The number of traded companies further declined since the early 2000s due to M&A activity, the increasing role of private equity, and venture-backed start-ups holding out longer for IPOs.

There are nearly 500 venture-backed companies with valuations that exceed $1 billion, and they are commonly known as unicorns. For comparison, there are only 2,000 listed companies with valuations above $1 billion, so there are clearly a number of strong candidates to go public. The demand for these new listings is also apparent. IPO volume in June and July hit the highest level in years, and nearly 250 listings have been carried out worldwide so far in the second half, with technology and healthcare sectors leading this trend.

Special Purpose Acquisition Companies (SPACs) have been in the news, and these are listed companies that do not actually have any business operations. Their goal is to purchase another business within a set time frame. The number of SPACs is growing, demonstrating interest that hasn’t been seen since the late 1990s.

Some of the IPO surge can be attributed to postponed offerings that had been scheduled for earlier in the year. The coronavirus disruption caused a steep drop in IPO activity in early 2020, and the number of companies going public fell nearly 50% in April and May. Nonetheless, the sheer volume of high-profile IPOs is noteworthy and has investors interested.

Patterns among upcoming IPOs

The surge in new listings is common among U.S, Chinese, and European exchanges, indicating a global trend rather than a phenomenon unique to one nation. As seen earlier in the second half, the offerings are dominated by technology and healthcare stocks. These are the sectors that appear to have been most financially isolated from the coronavirus and have potential for rapid growth even after the economy stabilizes.

As is common with IPOs, many of these companies have been delivering exceptional growth but are not yet profitable. That’s OK with most of the investors who target growth with tech darlings. In the growth investor mindset, any profits taken would redirect cash flow away from marketing, product development, and the building of corporate infrastructure necessary for these companies to grow into the massive scaling opportunity. As such, bullish investors would see profit-taking as an irresponsible use of capital at this juncture, and poor stewardship in the quest to maximize long-term shareholder returns.

The hidden message

For all the above reasons, it makes perfect sense that there should be a relatively robust IPO market in the back half of 2020. However, the sheer volume of big-name offerings indicates that there are some triggers that are enticing those companies to finally take the big payday for early investors.

In some instances, temporarily low cash flows from the COVID-19 disruption, paired with soaring public equity valuations could entice management to move. Consider the case of Airbnb, which is experiencing a disruption as fewer people travel worldwide, but should have stable prospects in future years. In general, the rebound in tech valuations is good timing from the perspective of listers, at least on the basis of fundamentals.

The current crop of companies are certainly enthused by the performance of this year’s successful listings. Further, the holidays are a notoriously bad time to go public, as investor attention is divided by family, travel, and time otherwise out of the office, so many of these deals are being filed to close before the holiday season. There is also speculation that these IPOs are being scheduled to occur before the presidential election, an event that generally causes some market instability in the short term.

With all of these reasonable considerations, it is implied that if this is a fantastic time to list, with 2021 likely to be less appealing. Market instability and economic uncertainty are clear risks for prospective offerings. This level of enthusiasm hasn’t been seen since the 1990s, though investor behavior was far more exuberant at the time. It would be completely unfair to compare Snowflake’s financial situation to Pets.com, yet there are still salient lessons to learn. Getting in relatively early in a great company with long-term prospects generally isn’t a bad thing, but investors should be wary of the risks.

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Ryan Downie has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.