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After almost two years of little to no activity, a flurry of initial public offerings (IPOs) is generating plenty of investor interest.
Microchip designer Arm Holdings PLC ARM-Q, grocery delivery company Instacart, also known as Maplebear Inc., CART-Q, and marketing automation company Klaviyo Inc. KVYO-N all made their market debuts in September – and enjoyed impressive opening day jumps from their issue price.
The IPO phenomenon has many investors wondering if they should be looking for the next hot new listing to give their portfolios a boost.
“Investing in IPOs can be very attractive, but it’s all a question of timing, which makes it a little more challenging,” says David Barr, chief executive officer and portfolio manager at PenderFund Capital Management Ltd. in Vancouver.
“We generally find that IPOs tend to be more attractive coming out of recessions than, say, at the end of a cycle. That said, the timing challenge continues.”
Mr. Barr says he has found that when there’s a flurry of IPOs, the first couple of IPOs that come out can be priced attractively and investors can do well on them.
He cites the Canadian example of Dye and Durham Ltd. DND-T, which was one of the earlier IPOs in 2020 and is still trading at almost twice its IPO price, whereas other IPOs that followed have subsequently not done as well.
As far as determining whether a specific IPO is worth investing in, Mr. Barr says a key factor is determining the quality of the business; for his firm, part of that due diligence is getting to know companies over time.
“When a company decides to IPO – if we know [the company] – then we have a good starting point to assess it as an investment opportunity,” he says. “If we don’t know it, then it’s more challenging to fully assess it in a short time frame.”
Look at market conditions and comparable companies
Another issue to consider is current market conditions, and the analysis on that front might seem counterintuitive.
“We always look at market conditions and whether the environment is attractive,” says Bruce Campbell, founder and portfolio manager at StoneCastle Investment Management Inc. in Kelowna, B.C.
“What we find is when markets are super hot, the valuations often aren’t as good, and you can’t usually get what you want, so it’s a bit of a balancing act.”
When markets aren’t that strong, there really isn’t much that comes to the market, and the businesses have to be stronger to get a good response from the IPO, he adds.
Mr. Campbell says his firm then looks at companies that are comparable to the new IPO.
“Quite often, the history of the company going public isn’t that long, so what we try to do is see what those comparable businesses have been growing at, and what the IPO company has been growing at, and why is it different or the same,” he says.
“If it’s a higher growth company, we try to figure out what they have that is going to make it attractive, or not.”
Mr. Campbell also says his firm is careful to make sure any IPO investments match the risk and volatility profiles of his clients.
“When markets are frothy, we might have clients say, ‘Hey my neighbour told me about this great IPO coming to market,’ and we have to circle back and say, ‘Well, if you really want to do this, we’ll have to change your risk profile,’” he says. “And quite often, people will recognize that maybe they’re being too aggressive.”
Even with IPOs, thinking long-term is still important.
“Sometimes, IPOs can work out really well if you’re not thinking about what kind of profit you’re going to make on day one,” Mr. Campbell says. “There are good companies that might not get the hype but over time, you can end up making more money than if it was a ‘hot issue.’”
‘Avoid the hype train’
Despite the potential gains, some investment advisors would rather avoid IPOs altogether.
“I believe there is often a history of hype around IPOs, and advisors and their clients need to be careful to not get run over by the hype train,” says Jeff Hull, senior financial advisor with Manulife Securities Inc. in Toronto.
“Marketing teams and investment bankers help craft alluring stories and can cause FOMO [fear of missing out] for many investors.”
Mr. Hull notes there’s an interesting parallel between Martha Stewart Living Omnimedia Inc. and World Wrestling Entertainment, owned by TKO Group Holdings Inc. TKO-N, and the recent Arm Holdings IPO.
Martha Stewart and Vince McMahon took their companies public on the same day in 1999 – but only made 10 per cent of their respective companies publicly available to investors. Because there was such demand, and only 10 per cent of the float was available, it caused frenzied demand as their IPOs launched.
Arm’s IPO replicated the same strategy, taking only 10 per cent of the company public. The much-anticipated listing rose about 25 per cent on day one but has been losing steam since.
“It’s often best to buy an investment when everyone else isn’t focused on it and bidding it up to irrational heights,” Mr. Hull says. “Take a lesson from Martha Stewart and fake wrestling to see how an IPO like Arm and others could play out and decide if [and] when to enter.”
The best time to enter a train is when it’s stopped, he says.
“There is a great chance you will get an opportunity to buy a great company at a discounted price once the IPO and excitement subsides,” he adds. “If you’re patient and disciplined you could be rewarded handsomely.”
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