It looks like the window for Initial Public Offerings (IPOs) is open. SpaceX has announced its plans to list in the next couple of weeks. We’ve heard similar rumblings from Artificial Intelligence businesses OpenAI and Anthropic, who are hoping to list in the second half of the year. While we don’t invest directly in IPOs, the news has prompted a number of discussions within the team.
In general, we should welcome IPOs. Globally, the number of listed companies has been shrinking for years, partly reflecting the burden of being a public company, the greater availability of private capital and increasing industry consolidation. That’s not great news for public market investors, who would rather have more listed companies to choose from. Increasing the investable universe should be a good thing.
That said, there are a few reasons to be wary of IPOs, at least in the short term. One consideration is IPOs as a measure of excessive optimism. The chart below shows the number of IPOs per year in the US. As you can see, during the “Dot-Com era” (the 1995-2001 period defined by the rapid commercialisation of the internet and a massive speculative stock market bubble) the number of IPOs increased dramatically as investor optimism increased. Perhaps not surprisingly, the quality of those IPOs declined as standards slipped and many of those businesses disappeared in the early 2000s. In contrast, the recent strong performance in equities has not been accompanied by a sharp increase in the number of IPOs. We think that partly reflects investor caution, but the growth of private markets has also played a role, with company owners happy to stay private (unlisted) for longer than in the past, funded by venture capital and private equity.
Do recent announcements suggest a flood of IPOs is coming? We’d guess not – SpaceX, Anthropic and OpenAI are unusual in the size and relevance – but it’s something we’ll continue to monitor.
Another point is more practical. If a fund manager wants to buy into an IPO, they often need to sell something to fund it. That could put selling pressure on existing stocks. It shouldn’t be very relevant for a small number of IPOs, but it could have an impact if we saw a sharp increase in the number of companies looking to list.
Investors sometimes look at the performance of IPOs as an indication of market sentiment. If there’s a lot of demand for an IPO, then perhaps it’s a sign of optimism about the broader market. On the other hand, a disappointing IPO – where investor demand was weak or the stock sold off immediately after listing – could be taken as an indication that investor appetite has declined. That’s possibly particularly true at the moment, given the extent to which Artificial Intelligence is driving economic growth and investor interest.
At Moneyfarm, we typically invest using ETFs that are based on market indices. We need to pay attention to how those indices are constructed. When it comes to newly listed companies, different indices have different rules around inclusion. A tech company could be included in the Nasdaq relatively quickly, perhaps in a matter of weeks. Standard & Poor’s (S&P), on the other hand, has stricter criteria – for instance around historical profitability – that might make it tougher for a new company to gain entry.
The weighting of the company in the index is also partly based on the “free float” – what percentage of the company can actually be traded by investors. A large market capitalisation doesn’t necessarily translate into a large weight in an index. It will be interesting to see if the index S&P considers relaxing its rules to ensure that these companies become eligible faster than we might have expected. In terms of performance, it’s worth remembering that indices don’t include a company at IPO, and so wouldn’t benefit from any initial rally in the stock after listing, and might suffer in the short-term, if the newly listed company drifts lower after an initial pop.
So where does this get us? IPOs create a potentially exciting new set of companies for investors to evaluate and invest in. At Moneyfarm, we don’t invest in IPOs directly, but we will be paying close attention to learn more about these businesses and understand more about investor sentiment. When we look at equities today, we think equity returns are being driven more by strong earnings growth than a sharp increase in valuations, but we’ll continue to monitor sentiment indicators for signs of exuberance or disappointment.
*As with all investing, financial instruments involve inherent risks, including loss of capital, market fluctuations and liquidity risk. Past performance is no guarantee of future results. It is important to consider your risk tolerance and investment objectives before proceeding.
