Obsession can be defined as an idea or thought that preoccupies a person's mind. From what I have seen recently, obsession can be the state of not just a single person's mind, but a group of minds with the same ideas or thoughts preoccupying them. And in the investing world, there seems to be an obsession with IPOs, or Initial Public Offerings, as of late. So what's all the hype about?
Before we look at this obsession in detail, what exactly is an IPO, you might be wondering. An IPO is an offer by a company to allow the company to be publicly traded on a stock market, from being held privately before. It is a way of raising funds to create expansion and growth opportunities. Going from a privately-held to publicly-traded company allows small retail investors (like me and you) to purchase stakes in the company. Private brands that already have fairly universal (or at least national) brand recognition can have quite the surge in number of shareholders upon completing an IPO.
The way an IPO is executed is through a process that has underwriters (investment bankers that help raise capital for the company and determine share details), legal teams, certified accountants and company insiders discuss options and gather information that would be required for an IPO. Because this is the first time a company would be going public, they would have to adhere to guidelines and rules specified by the Securities and Exchange Commission (SEC) in the US or the Investment Industry Regulatory Organization of Canada (IIROC) in Canada before they would be allowed to be listed publicly. Recent financial information and statements as well as growth plans would be some of the required documentation, giving investors some idea of what the company's current financial position looks like, and making them comparable to publicly-traded companies.
Once all requirements are in place and the company is approved to be listed on a stock exchange (whether it be the TSX, NYSE or NASDAQ, for North America), a date for the IPO is chosen and details including the IPO price and number of shares are made public. For a period leading up until an IPO date, investment bankers from the related branches of each underwriter would court institutional investors (think exchange-traded funds (ETFs), pension funds and hedge funds, for example) to sell them a portion of the shares at the IPO price. For this reason, it is generally almost impossible to obtain shares of an IPO before the IPO date, except indirectly (if you happen to have your funds managed by one of the institutions).
And that leads nicely into the obsession and hype - which typically happens on and after the IPO date. When the company become public and retail investors can finally buy them, IPOs typically see huge surges in share price in the first few days of trading. Once the heavy trading begins, you tend to see a period of share price declines, often ending up with share prices that are lower than the IPO price that all those institutional investors paid. Let's look at a few examples to see this in action. You should also keep in mind the typical lock-up period for an IPO, which is usually 6 months. All the insiders holding shares of the IPO cannot sell their shares during that time, so after 6 months it is not unusual to see another period of share price decline.
NYSE: SNAP (Snap Inc.) - USD$17.00/share IPO
TSE: ATZ (Aritzia Inc.) - CAD$16.00/share IPO
TSE: GOOS (Canada Goose Holdings Inc.) - CAD$17.00/share IPO
You can see that the extremely hyped Snapchat (Snap Inc.), after little more than a couple of weeks of being traded, is heading towards its original IPO price of USD$17.00, and my prediction is it will continue to go lower. Think about it - Snapchat is a single app for mobile phones that has (in the most recent fiscal year) lost almost USD$1 billion. There is also growing competition from Instagram with the disappearing photos/videos and there could easily be another app being developed right now that is ready to overthrow Snapchat with just a few extra features. Valuing a company that is essentially an app and losing ridiculous amounts of money at more than USD$20 billion is a highly risky move. If they do not create another homerun of an app or improve Snapchat substantially with the ability to generate very significant revenue from it, Snap Inc. as a company would be in a lot of trouble, and shareholders would be losing the little equity they have very quickly.
Aritzia Inc., an in-style fashion retailer with decent growth prospects (geographically, especially) is trading below its IPO price after just a few months of being publicly-listed. Keep in mind, these are the same few months that pushed the Toronto Stock Exchange (TSX) to record highs. The fashion industry is generally a very risky one to be invested in because of how quickly brands can go out of style. Even a 28-year-old brand that focuses on high-quality North-American made basics and timeless pieces like American Apparel went bankrupt, only to have the intellectual property (IP) and other assets strategically purchased by Gildan Activewear for a mere $88 million. Even if Aritzia can pull off the growth that shareholders are expecting, that will simply allow the fundamentals of the company to catch up to the expectations of the inflated share price.
That brings us to our freshest debut, Canada Goose Holdings Inc., a well-known brand with celebrity endorsements and representing the epitome of high-quality Canadian luxury outerwear. Let's look at just a single number to get a sense of what we are dealing with - the trailing P/E ratio. For Canada Goose, it currently sits at a whopping 95.8 after a beautiful 2-day run that pushed the entire TSX up a bit. That means that if this company is to ever become remotely fairly valued, it would need to grow earnings by 300% so it could trade at a much more reasonable 24 P/E, which is still a bit high when considering historical TSX P/E ratios, which average in the mid- to high-teens. Now that all the excitement has had a full weekend to settle in, my prediction is a steady decline for the next few weeks as people realize that they would probably get better value from simply buying a real $1000 Canada Goose jacket than hold onto the shares.
IPOs represent not just obsession, but a lot of passion and blind optimism. These urges are typically not ones you want to mix with investment strategies, as it is the peak of letting emotions control decisions. When a fresh, new company is out and ready to be traded, it can be very tempting to want to jump on board and take part in becoming an owner of a new, exciting venture. But, a new company with limited information and experience creates uncertainty and expectations that are very easy to fall short of, as history has shown.
My recommendation for IPOs is to leave them until you see valuations and fundamentals that actually reflect the position of the company in the market.