There is no sure way to predict a nascent bubble for any asset class, but there are some fairly similar warning signs that appear before an asset's value rises above realistic standards. The latest evidence of possible bubble formation comes from the dazzling success of certain initial public offerings (IPOs).
The most recent of these is cloud data software maker Snowflake (NYSE :), whose first-day trading rise doubled its IPO price. That 104% gain at the opening bubble was the third-highest pop for an IPO of $ 1 billion or more on a U.S. exchange, and the largest since Florida-based rental company Herc Holdings (NYSE 🙂 was made public in 2006. according to Bloomberg data.
Snowflake Diagram.
The same day, Jfrog (NASDAQ :), which makes tools for software developers, declined 47% in its trading debut after its initial public offering raised $ 509 million. In addition to these two recent examples, there have been many IPOs this year that showed investors lining up to get the bit they hope may be the next Zoom (NASDAQ 🙂 or Amazon (NASDAQ :).
Biotech company CureVac (NASDAQ 🙂 rose 249% on the first day of trading, while software-as-a-service company Bigcommerce (NASDAQ 🙂 gained 201% and biotech company Berkeley Lights (NASDAQ 🙂 rose 197%.
Investors' insatiable appetite for growth and easy monetary conditions are perhaps the two main reasons why these IPOs had a field day. The historical first-day pop was about 14% for an IPO. This year, that average is 36%, according to IPO tracker Renaissance Capital.
Long-term viability
Of course, it is nearly impossible to predict which of these companies will be successful and which will get their investors in trouble. However, history tells us that the early success of an IPO is no guarantee of the long-term viability of the company.
A Bloomberg analysis of companies that debuted since the financial crisis and fell more than 100% on their first day of trading shows that most stocks have fallen since their initial rise. According to Renaissance research published by CNBC.com, the 11 other IPOs this year that are up more than 100% on day one have achieved an average negative return of 1% from the close of day one.
The usual culprit in an IPO debacle was the cash burn that investors initially ignored, as these companies show a debt-laden path to growth. Snowflake, for example, is a great company with strong growth momentum, but the business has yet to make a profit and is still burning money.
And buying up investors pushed its market cap to more than $ 70 billion, six times higher than what it received in February in a private round of financing. That means management is now under a lot of pressure to perform as Wednesday's price action has valued the company more than 70 times over the run. Zoom Video, one of the most successful IPOs of the past year, trades at just 40 times forward sale.
Bottom Line
Investing in IPOs can be a successful bet in the short term, especially when a lot of money is looking for a few new ideas, but that initial euphoria may not last forever. Investors should view these opportunities with a healthy degree of skepticism. Their stock prices cannot keep growing at breakneck speed forever and these companies have a tough road ahead of them to show sustainable profitability.
