Last year was the year of the initial public offering with a record 1,035 companies going public over the 12-month period.
That was an increase of 120% over 2020, which is also a record year with 480 companies hitting the public markets.
The track record of these IPOs, however, has been downright terrible. Of the 1,035 companies that went public in 2020, only 315 have achieved positive returns. Of these, only 208 have achieved a positive return of more than 1% and only 76 have returned more than 10%.
There are always going to be some bad eggs in a basket as it is unrealistic to expect that every single IPO does well in the years after the company hits the market. However, the crop of companies that arrived in 2020 seem to have done particularly badly.
Around 40 have lost more than 90% of their value so far, while around 70 have lost more than 80% of their value, implying more than 10% of the companies that debuted in 2021 have effectively wiped out their initial investors.
To recover from a loss of 80% or more, a company would have to return over 500%.
Considering the fact most stocks do not outperform bond yields over the long term (and I am talking about 20 years here), it seems incredibly unlikely a company that is down 80% since its IPO will ever return a positive profit for investors (although there might be some exceptions).
The key lessons from 2021
I am not going to weigh in on any of the companies that have performed so badly over the past year or so, but I do think there are a lot of lessons investors can take away from the carnage of the 2021 IPO crop.
The most important lesson seems to be that 2021 was a great example of the madness of IPOs.
Last year, companies clamored to go public and raise money from investors amid a buoyant market and exuberant investor sentiment. Investors stopped asking questions. They just wanted to buy the most impressive company no matter what the price.
This allowed companies to take advantage of investors and the market. They could get away with exceptionally high valuations without investors questioning whether or not they were worth the money and forecasts.
Special purpose acquisition companies were particularly guilty of this. Many of these entities have since come out to inform investors that the forecasts they published at the time of their IPOs are no longer relevant.
We cannot really blame companies for taking advantage of investors. After all, investors are supposed to do the work themselves. If they are not prepared to ask questions and rigorously interrogate management about growth projections, then who will?
Investors who were willing to overlook these facts in the hopes of making money are not investors. They are speculators and gamblers.
The 2021 crop of IPOs also shows why it is essential to avoid companies reliant on the kindness of strangers to fund operations. Very few businesses that came to the market last year were profitable and cash flow positive. Rather, they have been relying on investors and other sources of capital to keep the lights on in the hopes that they will profit one day.
Unfortunately, this only works as long as confidence remains. The second confidence evaporates or the cost of capital increases, the whole tower of cards can collapse very quickly. And that is precisely what has happened. As confidence has evaporated with the Federal Reserve hiking interest rates, access to financing has become harder to get. Investors have fled these companies as a result.
Those are the two big lessons of the IPO market in 2021. Investors need to beware of companies trying to sell themselves and those businesses that rely on strangers' kindness to keep the lights on.
