IPOs tend to receive considerable media attention, which often leads novice investors to believe that they represent the market’s next golden opportunity. And with the number of IPOs (initial public offerings) expected in 2024 indicative of a recovery, they are once again in the spotlight. But the real value offered by IPOs is often misunderstood, as was highlighted by the recent flops of Reddit and Trump Media & Technology Group.
An unprecedented 2,436 companies went public in 2021, but the next two years saw a historic decline. There were a record number of IPOs in 2022 and 2023, and publicly traded companies with valuations of $1 billion or more were at their lowest level since the Great Recession, according to Adam Parker of Financial Timeswhich pointed to high interest rates as the main culprit.
However, it has not only been the Federal Reserve’s monetary policy that has limited the number of IPOs in the recent past. Overvaluation and underperformance are a growing concern on Wall Street.
“Since 2020, the average IPO relative return as measured by first-day closing price has lagged its industry peer by more than 20 percentage points after the first year,” Parker wrote. You noted that more than 60% of publicly traded companies lag more than 15% behind industry averages a year later.
So why, then, does the fervor for IPOs persist? In many cases, this can be attributed to investors’ lack of education.
Reddit and Trump Media as IPO Case Studies
Two companies that had IPOs this year have taken the Internet by storm. Reddit (RDDT), an aggregated news social network with more than 71 million daily users, debuted on March 22. Trump Media & Technology Group (DJT), which owns the former president’s Truth Social platform and went public through a SPAC merger with Digital World Acquisition Corporation, followed on March 26.
Shares of RDDT, a company that has not reported a profit since its founding in 2005, gained more than 7% in its first five days of trading. DJT has found even greater success since inception, with shares rising nearly 33% in the first two days of trading.
The joy surrounding their debut was short-lived, however. Over the next three weeks, Reddit shares fell more than 17%. Then, less than a week after its IPO, Trump Media revealed that in 2023, it posted a net loss of $58 million last year on revenue of just $4.1 million, sending shares down by more than 65% from its post-IPO high of $66.22 to $66.22. $22.84 by April 16th.
To illustrate such losses, an investor who purchased $1,000 worth of RDDT on the day of the IPO would have an investment worth approximately $830. And if that person had invested $1,000 in DJT on its debut, those shares would only be worth $350.
However, the excitement surrounding both IPOs generated massive trading volume, with DJT reaching 26 million trades in a single day and RDDT surpassing 44 million on the day of its debut. These figures suggest that investors are overlooking the fundamental flaws of both companies.
Between December 2022 and December 2023, Reddit’s total debt increased by more than 32% and its net cash flow was -$84.84 million, leaving it with annual earnings per share (EPS) of -1 $.54. Before come out. The consensus EPS forecast for the company’s first quarter earnings announcement on May 7, 2024: -$7.59. For context, negative EPS indicates that a company is losing money, and when EPS drops, stock prices tend to follow suit.
Meanwhile, despite the precipitous drop in price, Trump Media shares remained above a low of $17.50 in its first 30 days of trading, allowing former President Donald Trump to take advantage of a merger clause that gave him entitles you to an additional 36 million shares – worth approximately $1.17 billion, bringing the total value of your stake in the company to approximately $3.7 billion.
In a letter to shareholders, accounting firm BF Borgers CPA PC, which is acting as the company’s auditor, said Trump Media’s ongoing operating losses “raise substantial doubt about its ability to continue.”
Are IPOs good investments?
According to financial services and consulting firm Edelman Smithfield, 91% of investors are “likely” or “more likely” to invest in IPOs in 2024, which means a lot of people are ignoring the writing on the wall.
IPOs have an exceptional failure rate, with studies finding that as many as 80% of these companies face long-term insolvency. Among the companies listed in 2023:
- Warrantee Inc. (WRNT) has seen its shares drop 88% since it went public on July 28, 2023.
- Lucy Scientific Discovery (LSDI), which debuted on February 10, 2023, saw its shares plummet more than 96%.
- Shares of EV technology company U Power Limited (UCAR) have fallen 99% since its IPO on April 21, 2023.
Often, IPOs involve deeply flawed companies with unattractive balance sheets. But with the proliferation of traders, often self-taught, since 2020, many people are ignoring fundamental analysis, which aims to determine the true market value of a stock by evaluating its financial data, in favor of technical analysis, which aims to predict price trends based on the analysis of stock charts, in the hope that the charts say the opposite of what balance sheets and cash flow statements are telling them.
There are exceptions to the rule, of course. While most IPO share prices are lower one year after going public, 20% buck this trend.
Companies like Birkenstock (BIRK) and ARM Holdings (ARM), both debuting in 2023, have seen growth and stock appreciation since going public. Shares of BIRK, the German shoe maker, have risen nearly 24% since going public on October 13, 2023. ARM, buoyed by high demand for semiconductors, has seen its shares rise nearly 61% % since its debut on September 15, 2023. .
However, in these cases, the companies are legitimately thriving businesses. Birkenstock, whose rugged leather sandals have a global reach, was founded in 1774, is profitable, has produced positive free cash flow and is enjoying quarter-over-quarter EPS growth. ARM has also produced consecutive quarters of positive earnings, driven by rising demand for microchips and an industry that, according to consultancy McKinsey & Co., is in the midst of a decade of growth that is expected to culminate in a valuation of trillion dollars by 2030.
For novice and passive investors, the main takeaway is that IPOs present high risks and that it is often unwise to bet on trendy companies that make headlines. Adopting proven and historically productive strategies, such as dividend reinvestment, dollar-cost averaging, and index fund investing, will help you avoid the financial traps of companies like Reddit and Trump Media.
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