Here’s When to Buy an IPO

Transcript

Ken Fisher:

There's been a little more news lately on IPOs, meaning initial public offerings, and people who've paid attention to my commentary over the decades know that I'm generally pretty negative on initial public offerings. And so lately, some folks have asked if I've changed my views on that at all. And man, it's good to keep an open mind. The world changes. Lots of things change. Some things don't. I don't think this changes. IPOs are brought to the marketplace when it's good for the company to bring them, when it's good pricing for the company to bring them. Not when it's good pricing for you. And so accordingly, historically, the average IPO has been a loser's game. Or as I wrote in my 1987 book, The Wall Street Waltz, which now feels like it's nearly forever ago. IPO really means it's probably overpriced. Now, some IPOs end up being spectacular winners and hence from that you get the reality that whether it's once upon a time, a Microsoft, or more recently, a Nvidia or any of the infamous MAG 7. Oh, by the way, the MAG 7 became a MAG 7 before people started getting so carried away with Nvidia. All of that, they all went public in an IPO and there is some tremendous desire to catch the next one. The reality is usually, but not always, it's better to wait until it's been public for a year or so. Something stumbles. Stock goes down. Buy it then. It's not that because something went public it's bad forever. It's probably overpriced. And the reality is, down the road when they have a stumble, it probably gets priced appropriately and you get a better bite at the apple. So my view of all of this is I'm never overly enamored with a single stock. I never am looking to buy something from the private marketplace that is going to go public, and that I have any confidence that I can pick will become the next super stock of the world. I do want super stocks in my portfolio, but I think I can get them better once they've been public for a while and you can analyze them better. You can know a little more of their history. You can watch him do the dance, and you can watch him stumble a little during the dance and see how much grace they have when they stumble and how well they come back. And that's a better time to buy. Let me go into this a little more. I am not overly enamored with having to get the best valuation when you buy things. I am not per se a value investor. I'm a person who does think about pricing, however, and I do believe that great companies that are going to grow really well legitimately deliver a much higher valuation than companies that don't really grow much at all, or worse. And usually, not always, with IPOs, they're being marketed. Maybe a different word is masqueraded as the greatest thing since sliced bread. And you should own this one. Now mind you, not always (because IPOs are done slightly different ways), but most of them have big fees for the investment bankers that are bringing them public. They put in a serious marketing effort to get you to pay up for them, and therefore they have every reason to put their best foot forward as best they legally can. This is another reason, but think about it in a different way. And I just want you to get this in your bones. And I'm not going to take too much more time on this. But if you think of a stock that's selling at five times earnings, well, it's not going to go public. Why is it not going to go public? It's not going to want to go public because five times earnings flip that into an earnings yield. Instead of P divided by E, E divided by P. And now you've got one divided by five. That's 20%. That 20% is more or less the cost to that company. Not perfectly so but it's approximation what it costs that company as a price if it wants to create new stock. That's a really high price to the company. It's going to get financing cheaper if it just can find a way to borrow some long-term debt, even if it's junk debt at high interest rates. So it doesn't want to go do that, go public at a low valuation. Let's say it's instead selling at a very high PE of 100. Well now 100 divided by one. Flip that into E divided by P. That's 1%. And that's very cheap money to the company. If the company sells stock, and in fact, it's so cheap that it beats any kind of debt that it's going to get in the world that exists as we know it today. So the higher valuation company that's privately held has every incentive to get cheap money through own stock, selling it to the public in newly created shares. The company that's a real deal and very cheap, whatever that means, has no real incentive. Now, mind you, between five times earnings, 100 times earnings, there's a big spread and all kinds of companies and all kinds of stuff. But my point to you is that the company wants to go public as best as it can, and only will if it's on the higher end of that spectrum, making the cost of capital to it low. It doesn't want to do it if it's on the lower end of the PE or valuation spectrum, however you calculate valuations, where that cost of capital to the company for those newly created shares, and the money that it's getting therefrom is very expensive relative to other financing options that are not equity. So the game is stacked against you and it's a little bit like going to Las Vegas. The odds you win and so some people win, but the odds of winning are low. The odds are worse for you with IPOs than they are if you go to Las Vegas. And that's just the way it is. Again, my advice to you, if you want to catch the next Nvidia or the next whatever it is, let it go public first. Sometime in the next year or so, maybe two years, maybe three years, the odds of it having a stumble and a big price drop and getting to reasonable valuations, and where you can understand the company better is very high. Not 100%. Sometimes these companies come out flawless and never have a hiccup. But most of them do. And I'd wait for that on average and be prepared to forsake the perfect one for the very, very, very, very good one that has a stumble, which is most of them. Thank you for listening to me. I hope this has been useful, educational and helpful for you, and I look forward to the next time that I can share some of my accumulated knowledge from training and 50 years of research, plus, and accumulated experiences. Thank you much. Hi, this is Ken Fisher. Subscribe to the Fisher Investment YouTube channel if you like what you've seen. Click the bell to be notified as soon as we publish new videos.