I came across an article by ValueWalk that claimed 2014 was the year in which IPOs reached record numbers since the year 2000. It also went on to imply that the stock market may be experiencing an IPO led bubble. A notion I sometimes like to think of as the “app-bubble”. (Pardon the reference to the infamous dot-com bubble).

Do the # of IPOs correlate with Market Bubbles?

The simple answer is no. First lets look at some charts, and then I will attempt to explain the correlation as I see it between market “bubbles” and IPOs.

chart1

# of IPOs since 1994. Numbers from a research conducted by Jay R. Ritter, University of Florida. The numbers exclude ADRs, unit offers, close-ended funds, REITs, partnerships, small best efforts, banks and stocks not listed on CRSP (CRSP includes AMEX, NYSE and NASDAQ). The number of 2014 is adjusted based on these exceptions.

chart2

These numbers represent the end of year closing price of the S&P 500 from 1994-2014.

The graphs presented above make the following noticeable assertions:

  • When markets were trending upwards, the # IPO numbers were always exceeding 100 per year
  • We see a sharp decline in IPOs from year 1996-1998 even though the market was doing really well.
  • The year after each reversion saw a steep decline in IPOs. Look at 2000 and 2008.
  • Notice that # of IPOs do not start picking up until the S&P 500 is close to reaching its previous highs. Look at year 2004 and 2012.

This shows IPOs do not correlate with market bubbles. On the other hand, this shows that IPOs lag the market trend. During market crashes less companies go public compared to when the market is experiencing great bullishness. This makes logical sense, as the best time to get the most funding for your company would be to go public when the market sentiments are at an all time high. Great incentives are also present for venture capitalists and private equity holders of the company about to go public, which also determines the timing of the public offering.

Whatever the reason may be for IPOs occurring during periods of market bubbles, one thing is clear: there are a lot of incentives present for private investors and company presidents alike to get the most out of their time, effort and investment. Hence, we see a sharp increase in IPOs during market bubbles and decreases during market downturns rendering IPO as a lagging indicator of the stock market sentiment.

What does that mean for an average investor?

If IPO’s that occur during the time of high market sentiments imply higher valuations, is the average investor better off waiting till the market crash? To investigate this question I went through 200 companies that went public during the first six months of 1999. As we are currently trending towards similar numbers for IPOs and the nature of companies is commonly technology based, I chose January to June of 1999 as a study sample. The following is a pie chart that shows the number of companies that are still currently public, privatized/bought out and the companies that went bankrupt.

chart3

Of the 200 companies researched, a staggering 50 had gone bankrupt. The majority of the companies were either bought out by hedge funds, other public/private companies in their field, merged with similar companies or simply taken private by its management. To find out whether these deals were to the detriment of the shareholder is another case study in itself. The ones that remained public, at least half of them were not tech-based companies. The other half showed the following results:

chart4

The above results show that 63% of the time, an investor would have been better off waiting till the crash to purchase the stock that is still publicly traded. Only 9% of the time, an investor would be rewarded for participating at the initial price of the stock and 17% of the time the stock was not even worth buying after the crash. So just basing primarily on these numbers, the investor would have been better off being patient until the market sentiments turned bearish. The above analysis is solely based on price changes. An in-depth analysis is always necessary when looking at stocks during a market crash to ascertain which companies are sustainable moving forward

For an investor to find the stock with good fundamentals during a period of negative market sentiment, a lot of analysis is required. One of my next pieces will go further into detail about that subject.

Until next time,

Hyder

About The Author

Hyder Karim
Finance Professional

Hyder Karim - Graduate from Wilfrid Laurier University. I graduated with Accounting majors, however I slept through most of my fourth year. It was not until I graduated I realized that it was the lack of interest in accounting that caused me to snore during class. My transition into finance was more of an epiphany than anything else in my life, as I sat staring at my first pay check and thinking of ways that i could spend it that I realized I could do more by putting my money to work. And thus began the two year journey into the financial markets. I will be writing to you about my experiences as well as some simple skills that I picked up. If you have any questions regarding stocks, investment vehicles (mutual funds, etfs, bonds etc.) and products (RRSP, TFSA, LIRAs),

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