Are These Frothy IPOs Endangering the Dow's Bull Market Run?

The Dow Jones Industrials (DJINDICES: ^DJI  ) eased downward by 24 points as of noon EDT Friday on mixed earnings news from two key component stocks. From a longer-term perspective, investors have been bullish on the Dow and the broader stock market for years now, but many are worried about the possibility of a major pullback in the near future. To support their contentions, some commentators have looked at the market for initial public offerings, noting that many stocks are seeing dramatic first-day pops that in the past have been signals of unsustainably optimistic sentiment. Should the big jumps in shares of GoPro (NASDAQ: GPRO  ) , JD.com (NASDAQ: JD  ) , Zendesk (NYSE: ZEN  ) , and other hot IPOs be cause for concern?


Photo credit: Rafael Matsunaga.

What's up with IPOs?
There's no question that interest in IPO stocks is high enough to bring some truly impressive moves. When GoPro went public earlier this week, it jumped 30% in its first day of trading; today, the camera maker and budding media company has seen its shares jump another 26% by lunchtime. Chinese e-commerce giant JD.com only rose about 10% in its first trading day in May, but it has since boosted its overall return to about 50%. Cloud-computing customer-service specialist Zendesk soared 50% in its first day of trading and has just about doubled its offering price in the interim.

Yet there are a couple reasons to think that the IPO phenomenon doesn't pose a threat to the Dow Jones Industrials or the broader stock market. For one, even though the stock markets are near record highs, their gains for the year are relatively small, with the Dow up just 3%. That doesn't suggest that the broader market is rising in line with soaring IPOs.

Source: Idaho National Laboratory, Flickr.

More important, many of the hottest sectors for IPOs have already seen big corrections in 2014. The biotech industry, for instance, was extremely popular early in the year, but the sector took a huge hit in a general exodus from high-momentum stocks more broadly. That dose of reality should be good for IPO activity going forward.

What to watch for
For small companies, a lot depends on what they can bring to the table from a profit growth standpoint. Zendesk has grown revenue at a rapid pace, but it hasn't yet turned profitable. JD.com is going beyond its e-commerce roots to enter the Chinese social media space, and that could help drive results in the future. GoPro's potential consists not just of camera sales but from users wanting to showcase their videos, and GoPro has high hopes of turning that business into a key driver of profits for the overall company. If things go well, these companies could very well justify their early positive stock performance.

As some larger deals come to market, such as the long-awaited arrival of Alibaba and the spinoff of General Electric's (NYSE: GE  ) finance arm into Synchrony Financial, it'll be easier to get a read on the true state of the IPO market. For now, the performance of a handful of newly public companies shouldn't give Dow investors huge cause for concern.

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