Investing in IPOs is, at the very least, an exciting prospect. It typically marks the first opportunity for those other than private equity firms or company employees to take a stake in a hot new company.
A successful IPO can be a millionaire-maker for employees who were compensated with an equity stake and potentially a billionaire-maker for CEOs (and the investment banks running the IPO).
On the flip side, for every much-hyped IPO, there are dozens that hit Wall Street with little more than the wet thud of disappointment.
Generally speaking, if you’re buying an IPO as part of the initial allocation you’re maximizing your odds of success, but to paraphrase Groucho Marx, you probably don’t want to be part of any IPO that would have you as a buyer.
IPOs that price above their expected range typically rise 38% on the first day of trading, while those that do not are typically flat.
That’s intuitive at the very least: Stocks that are highly sought-after generate more investor interest and oversubscription, which is what leads to higher prices when shares are allocated and initiate trading.
Stocks that aren’t in demand don’t generate investor enthusiasm or cause IPO runners to start raising their ranges.
That leaves potential early investors in a tricky spot, if you can get the initial allocation, so can anyone else and it’s more likely to be a dud. If you can’t get the initial allocation, you could quickly find yourself paying a nearly 40% premium to the initial share price.
So other than generally avoiding IPOs until they’ve had some seasoning time (not a bad strategy), what can an investor look for to increase their odds of success?
A recent Goldman Sachs analysis of 5,000 IPOs in the last 25 years found two criteria that make for a successful IPO investment. Per Goldman’s Chief U.S. Equity Strategist, David Kostin (who helmed the team of analysts), these two criteria are:
“Greater than 40% annualized sales growth in their second and third years after flotation and positive net income by their eighth quarterly earnings report.
“Two-thirds of IPOs with these characteristics outperformed the Russell 3000 in their first three years with the typical company outperforming by 22 [percentage points].”
As much as the Goldman analysis serves as a word of warning about buying IPOs before they can prove their balance sheet bona fides, it also offers us a checklist of sorts for companies that have gone public recently.
Specifically, the second criterion of positive net income by their eighth quarterly earnings report is a binary and easily confirmed metric.
And with the end of 2023 barreling towards us, most of 2021’s IPOs have had adequate time to report a full eight quarters, meaning all we need to do is look at the companies that came public in 2021 and look for positive net income by Q8.
A few caveats since we don’t have the specific methodology of the Goldman Sachs analysis: 1) To manage results and control for one-off events we’re screening for 2021 IPOs that have achieved positive net income and remained there.
That removes a company like Coinbase (COIN) from consideration because they briefly achieved profitability during the cryptocurrency froth before going back to losing money and failing to post positive net income.
2) As Kostin noted, the other criterion is 40% sales growth in years two and three. With only two years of post-IPO data, we won’t have year-three information for any of the 2021 IPOs. We will, however, have analyst projections for year-three sales growth, which is an adequate starting point.
3) Keep in mind, the Goldman analysis showed that only two-thirds of IPOs with these characteristics outperformed the Russell 3000, so odds favor outperformance, but there’s no guarantee.
4) Lastly, 2021 featured a lot of SPACs. SPACs (special purpose acquisition companies) are subject to less stringent oversight and reporting requirements than IPOs, often leading to less mature companies using them as take-public vehicles. For this reason (and because Goldman’s analysis was focused on IPOs), SPACs were removed from consideration for this list.
So, with those caveats in mind, we dug through the companies that came public in 2021 to identify those that tick both boxes (or, given our use of analyst estimates for year three, tick a box and a half).
We sorted through dozens of companies, and most failed the net income test, including all but one of the 10 largest IPOs of 2021.
That company, Coupang (CPNG), came public in March of 2021 at a $60 billion valuation, second only to Rivian (RIVN) in terms of size. (Rivian has not reported positive net income in any period since its IPO, which disqualifies it).
But Coupang does deserve an honorable mention, and is probably worth keeping on your radar, as South Korea’s emergent e-commerce leader achieved profitability but is not growing sales at the 40% level (mid-teens this year and more of the same expected next year).
Shares have lost 64% of their value since the IPO and carry a weak buy rating from covering analysts, with an average price target just over 22.
Some notable (high-profile but didn’t tick the boxes) also-rans, in addition to Coinbase, Rivian and Coupang, are dating software stock Bumble (BMBL), web host/e-commerce/marketing provider Squarespace (SQSP), craft and hobby retailer Joann (JOAN), oat-based milk producer Oatly (OTLY), EV-maker Lucid (LCID) (also a top-ten IPO by valuation at the time it came public) and Singapore’s ride-hailing and delivery app Grab Holdings (GRAB) (also top ten).
After drastically paring down our list based on the net income test, we turned to sales growth and estimated sales growth, which in addition to squeezing out Coupang, eliminated a stock we’ve covered here at Cabot before, digital media verification company DoubleVerify (DV), which is lower by a much more modest 18% since coming public and, like Coupang, is simply not growing sales fast enough.
But it did lead us to …
Shoals Technologies (SHLS), the Tennessee-based provider of electrical balance of system (EBOS) solutions for solar energy projects in the United States. Per Shoals, “EBOS encompasses all of the components that are necessary to carry the electric current produced by solar panels to an inverter and ultimately to the power grid.
“EBOS components are mission-critical products that have a high consequence of failure, including lost revenue, equipment damage, fire damage, and even serious injury or death. EBOS components that [they] produce include cable assemblies, inline fuses, combiners, disconnects, recombiners, wireless monitoring systems, junction boxes, transition enclosures and splice boxes.”
The original pitch was to offer up 50 million shares at a price range of 19-21, but that was raised to 70 million shares in the 22-23 range. Even that adjustment didn’t satisfy investors’ appetites as the company ultimately came public in January with 77 million shares priced at 25. On its first day of trading, SHLS rose nearly 24% to close just shy of 31 per share.
Since then, shares have been cut in half, and the chart is nothing to write home about, with SHLS trading below both its 50- and 200-day moving averages. That said, shares are technically oversold and may be putting in a bottom here near 15, above April 2022’s all-time low at 10. It’s still in “falling knife” territory but is definitely worth monitoring for signs of a reversal; a close above 18 (52-week lows) would be a good start.
One final note on Shoals: Sales growth is pegged at 52.9% in 2023 with estimates at 36.4% next year, so that number will need to slightly exceed expectations to reach Goldman’s threshold of 40% sales growth in both years two and three. Even so, shares carry a buy rating and an average price target of 31 from covering analysts, about double where they’re trading today.
