Today's initial public offerings (IPOs) are higher-quality businesses than we've seen in many years, and many investors want to know why, so we outlined the reasons behind this phenomenon last week. Now, let's start eyeing recently public companies up close, to see if there are any worth following or -- in that rarer-than-rare case -- worth owning. (Editor's note: If you like following smaller companies, you might like Tom Gardner's new newsletter. He's seeking out Hidden Gems inside the market and you can get a free trial right now.)
Before we start to undress our first specimen, some important points bear addressing.
There's bad and good in IPOs
First, an IPO is a liquidity event for a company. The primary goals are to "repay" past investors and raise cash for the business. You don't see "reward new shareholders" as the immediate goal.
Second, an IPO can come anytime: too early, when it's desperate, at an OK time, or at an opportune time (and almost never too late). Some companies go public because they're losing money hand over fist and need to raise cash. You'll want to avoid those. Many companies go public because it's the next natural step in a successful life span. They've claimed a market, raised funds, grown sales, turned profitable, and now it's time to step things up a big notch. When the business outlook is bright, that situation might appeal to risk-comfortable investors.
But then a third point: Don't rush. If a business is great, you almost always have a long time to become a shareholder and still be vastly rewarded. Microsoft
Even in today's hyper-connected society, sought-after IPOs usually give investors opportunities well after their debut. For example, Netflix
In fact, eBay
Why invest in individual stocks?
Now, let's step back and ask: Why risk buying a stock at all? Most investors buy individual stocks, as opposed to index funds, for one primary reason: to outperform the market averages. Buying superior businesses at attractive prices in order to "beat the market" is what individual stock investing is about.
How do you do this? Two key ways: You either buy well-known, larger companies when they're irrationally priced (taking a lot of patience), or seek out obscure companies with value or potential value that is not yet priced in the stock (taking a lot of research).
So, why look in the IPO market?
Shares of newer companies typically offer greater pricing inefficiencies, both to the upside and downside, that an investor who isn't afraid of research and some risk can take advantage of -- especially now. Most investors are much more conservative after the bear market, so newer companies are not largely followed.
This may be fortunate for us, because as we discussed last week, today's IPOs are of a much better quality than a few years ago. The IPO market is, by the number of offerings, at a 30-year low, but because most investors are showing a lack of interest, we might be able to recommend one or two new companies as being worthy of your attention.
Everywhere, an IPO
Finally, there's an obvious but usually overlooked truth worth pointing out: Every company trading today started as an IPO. Since their heyday in the 1990s, IPOs have been tainted as "speculative claptrap." And although some of them are, most survive (and many thrive) as lasting businesses. Some new issues are even exceptional businesses that are about as inexpensive as they're going to be.
So, it's illogical to dismiss a company as too risky, too young, or too unknown just because it only recently began trading. That's akin to disliking the new kid at school because... hey, he's new. Only research and analysis can possibly start to tell you which businesses are strong and which are not. Any risks of novelty aside, whether a company recently debuted or not is hardly a parameter for future results.
Meanwhile, the main benefit of young companies is this: The good ones tend to have much more promise ahead of them than behind them.
On Thursday, our first company
We've endured that long-winded intro, but we can't go on because at about this length editors start to say, "Chop, chop." But that's OK. They would have insisted on the importance of those initial comments (or something like them) in this series about IPOs anyway.
On Thursday, we'll start looking at our first company, iPayment