This is the year of the IPO. Countless companies are coming to market in 2013, promising big potential, and investors are eating it up.
This week, Twitter (NYSE:TWTR) went public and surged 80% in its debut, Potbelly went public to a big debut last month. Even a boring old retail store -- The Container Store -- went public Nov. 1 to double in the first day of trading, thanks to underpricing by Goldman Sachs (NYSE:GS) and JPMorgan Chase (NYSE:JPM).
What we're seeing isn't an outlier. We've seen big IPOs go boom before. We've seen them go bust. But I think all investors can benefit from some historical perspective from the man himself, Ben Graham, Warren Buffett's idol and teacher and one of the best value investors to ever live.
Wisdom from The Intelligent Investor
Benjamin Graham loved to describe the market as Mr. Market, a potentially depressed investor with manic mood swings and an appetite for changing his mind with each passing day.
In his book, The Intelligent Investor, Graham spoke to the harsh reality of bull markets and IPOs, writing:
Somewhere in the middle of the bull market the first common-stock floatations make their appearance. These are priced not unattractively, and some large profits are made by the buyers in the early issues. As the market rise continues, this brand of financing grows more frequent; the quality of the companies becomes steadily poorer; the prices asked and obtained verge on the exorbitant.
No doubt we've seen the quality of your average IPO degrade even as prices turn higher. In 2009, such companies like Dollar General and Mead Johnson Nutrition went public at a time no one wanted to. Both are high-quality, highly regarded companies within their respective industries with long track records. Neither exploded out of the gate, though both have been excellent investments since IPO.
By 2012, Splunk went public as an unprofitable company, only to rise 100% on debut before crashing back to earth. Marginally profitable Facebook went public in what was a mess of an IPO, plummeting before rocketing higher every day to now. CafePress, a T-shirt shop on the Internet, went public, too, rocketing in the first day of trading, only to crater since then.By 2011, big IPOs were back to dot-com and start-up excesses. Zillow went public that year. So did Groupon, and Bankrate, a collection of financial websites.
In 2013, Twitter goes public at a valuation of slightly less than $30 billion. This for a company that hasn't produced a penny in profits.
Are we rushing into a new bull market?
These are just hand-picked examples, but they show the true excess in IPOs today. New companies are going public without a track record and without a penny in cumulative profits. Ben Graham also provides some historical perspective into the business of taking companies public:
One fairly dependable sign of the approaching end of a bull swing is the fact that new common stocks of small and nondescript companies are offered at prices somewhat higher than the current level for many medium-sized companies with a long market history. (It should be added that very little of this common-stock financing is ordinarily done by the banking houses of prime size and reputation.)
Noteworthy here is what is in parentheses. In Graham's heyday, the post-Depression, postwar stock markets, investment banks with any reputation stayed away from big IPOs, particularly those of unprofitable, low-grade companies.
Today, that's not the case. The investment banks have made a business taking anything public. Goldman Sachs, JPMorgan, and Morgan Stanley (NYSE: MS) are all too happy collecting fees by taking Twitter on a road show. In one example of how things have changed, Goldman Sachs analysts slammed JC Penney, only to help it raise $1 billion in a secondary stock offering just a week later.
The business has certainly changed. A half-century ago, which isn't that long in the slow slog of financial markets, no bank would ever think to trash a company, then work to sell its shares as part of a new equity raise. But today, in 2013, that's just business as usual.
Focusing on quality
A look back at the words of an intelligent investor who survived countless bull and bear markets can help us put the current IPO frenzy in perspective. As the losses during the financial crisis fall off mutual fund marketing materials and free information on most financial portals, we become increasingly disconnected from the poor performance of weak businesses in down cycles.
It's important to remember that a big bank's name on a newspaper advertisement doesn't make a great IPO. Banks are in the business of taking stocks public at prices that those same banks would never buy the stock.
Fool contributor Jordan Wathen has no position in any stocks mentioned. The Motley Fool recommends Facebook, Goldman Sachs, and Zillow. The Motley Fool owns shares of Facebook, JPMorgan Chase, and Zillow. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.