Business - INVESTOR TOOLS
September 12, 2004
Jay Loomis
Kathleen Smith remembers when the hottest Internet stocks soared 400 percent or more in their first day of trading. The gold rush surrounding these initial public offerings turned some workers at dot-com companies into paper millionaires - or even billionaires - overnight.
These days, such IPO fever, which symbolized the boom in the late 1990s, seems like a cautionary fairy tale of excess. That fantasy land disappeared along with the bubble market and took shareholder wealth with it.
“The stock market goes through fear and greed cycles that are accentuated with IPOs,” said Smith, the co-founder of Renaissance Capital, a research firm specializing in IPOs. “Eventually we will get back to the greed cycle. We are still in the fear part right now.”
In one sign of the lingering hangover from the bubble, there were only 221 IPOs from 2001 to 2003 as companies avoided going public during the longest bear market since the 1930s. That was less than a quarter of the 892 IPOs during 1999 and 2000. The IPO market has bounced back somewhat in 2004 - the best environment since the bubble - but remains far below the earlier peaks.
“There is not the froth in the market that there was a few years ago,” Smith said.
There have been 124 IPOs completed or announced in 2004, including Google, the Internet search company; Domino’s Pizza; and Advertising.com, a provider of online ad services.
The average IPO stock is up 2 percent this year, according to Renaissance Capital. That pales against the frenzied returns of the late 1990s, but is above the 0.3 percent decline for the S&P 500 this year.
The quality of the IPO companies has also improved with about two-thirds of the companies profitable, compared to only a quarter that were profitable at the height of the bubble.
Given the recent pickup, small investors are wondering if it is a good time to jump in.
“With above average selection and timing, you can increase the odds of good returns in this area,” Smith said. “People can now get involved with a market that is less filled with fluff.”
Renaissance Capital, based in Greenwich, Conn., has researched 5,000 IPOs since it was founded in 1991. The company was started by Smith, previously an investment banker at Merrill Lynch & Co. who helped take companies public, her husband William, a former manager at Bear Stearns, and Linda Killian, a former mutual fund manager at Citibank.
The founders have written a book titled, “IPOs For Everyone.”
“The IPO market is always new - new companies, new ideas,” Kathleen Smith said. “The success stories of the entrepreneur. It’s all there. That’s why we named our firm Renaissance Capital.”
The company’s Web site, IPOHome.com, includes frequently asked IPO questions, a glossary of IPO terms, research reports on IPO companies, a directory of foreign IPOs, and a report card tracking IPO performance. There also is a chat room where investors can discuss IPOs.
Smith continues to find the market stimulating.
“Every company has its own story,” Smith said. “You can open up a prospectus ... and you can learn how companies put themselves together, how they operate. That I find fascinating. In a hot market, I look at several hundred of those companies a year. ... This area, when it’s healthy, tells you that jobs are being created.”
People should be aware of the potential potholes, however, Smith said.
“It’s the most risky area of stock market investing,” Smith said. “And for that reason, it pays to do your homework and not take advice from cocktail-party chatter. It can require more research than if you were buying an already established stock.”
The company manages Renaissance IPO Plus Aftermarket Fund, a mutual fund that invests in newly public companies. Performance of the fund has closely correlated with the underlying IPO market. In 1999, the peak year for IPOs, the fund was up more than 114 percent. Yet in 2001, when the market hit bottom, the fund was down nearly 52 percent. Over the past five years, the fund’s average annual return is -12.2 percent.
Newly public companies can “be more volatile, and investors abandon the stocks more quickly because they don’t have a knowledge base,” Smith said. “They often are names that are not well known and the research is very limited. ... It is little bit like having a teenager who is just learning to drive. If they get in an accident, it is lot bigger than an adult getting in an accident, because the adult has been around longer and has a track record.”
For investors, IPOs can be hit-or-miss propositions that can lead to small fortunes or black holes.
Someone who owned 100 shares in eBay Inc., the popular online auction company, the day before its IPO on Sept. 24, 1998, has seen an initial $1,800 investment climb to $106,920, if they held onto the split-adjusted shares. That works out to a total return of more than 5,800 percent in less than six years.
But for every grand slam such as eBay, there are laggards.
MarketWatch Inc., which operates a financial Web site, zoomed from $17 to $97.50 on its first day of trading on Jan. 15, 1999. More than five years later, reflecting a lingering hangover from the tech bust, MarketWatch’s shares are down more than 90 percent to about $10 a share.
The uncertainty of how a newly public company will perform makes some investment advisers cautious about recommending them. At Wachovia Securities in Suffern, less than 5 percent of Peter Antonelli’s clients dabble in the IPO aftermarket.
“It can be a bit of a crap shoot,” said Antonelli, senior vice president of investments. “I advise people to be extremely careful.”
Antonelli recalls the late 1990s when much of the fabulous wealth generated from IPOs vanished after investors tuned into an uncertain outlook for profits. Some of those companies went out of business, leaving their investors with worthless shares.
“These things can sell off quickly and dramatically,” Antonelli said.
Chuck Carlson, editor of Dow Theory Forecasts, an investment newsletter in Hammond, Ind., advises investors to wait six to 12 months after an IPO to “let the euphoria wear off” before taking a stake.
One concern, he said, is high valuations. He said Google’s price is about 15 times sales following its IPO. That far exceeds eight times sales and 1.5 times sales for Microsoft Corp. and IBM Corp., two established players with long track records.
“You have a lot more historical information to value a company when you invest in an older company,” Carlson said.
As investments, IPOs also have lagged the broader market, according to a study by Jay Ritter, a finance professor at the University of Florida. From 1970 to 2002, IPO stocks averaged annual gains of 9.2 percent during their first five years of trading, less than the 13.4 percent for older companies of similar size, the study found.
The performance was worse from 2000 to 2002 when IPO stocks fell 15 percent a year compared to a gain of 8.3 percent for older companies, according to the study.
Another concern is that small investors can be at a disadvantage in getting initial stakes in IPO stocks. That’s because brokerage firms have traditionally allocated the shares to clients who either are wealthier or generate big fees.
“I got turned off from the IPO market in the 1990s when it seemed like the game was rigged,” said Charles Lieberman, chief investment officer at Advisors Financial Center, a money manager in Paramus, N.J. “It was hard to get the shares of the companies unless you were the chosen few.”