Demand Good for IPOs

Includes: CAR, GNC, HCA, MDLZ
by: AAII

Filings for initial public offerings (IPOs) this month are at a four-year high, another sign of the stock market's strength. Renaissance Capital, which compiles data on IPOs, counted 31 filings in April, the most for a single month since August 2007. Year-to-date, 82 companies have filed to go public, putting 2011 on pace to match last year's total of 257 filings and making it the second busiest year since 2007, when 299 filings were registered.

The IPO market is notoriously fickle, and merely filing with the Securities and Exchange Commission (SEC) does not ensure that a public offering will be completed. Therefore, it is also useful to look at how many offerings have actually been priced, the total dollar volume of the offerings, and how many offerings have been withdrawn. Year-to-date, 49 offerings have been priced, again putting 2011 on pace to match last year's total. Dollar volume, a measure of the total size of the deals, is at $17.8 billion, or 46% of last year's total. Withdrawals are also pretty close to last year's pace, with 15 deals pulled year to date.

These are good signs in that they show that there is an appetite for equities and that corporations are able to raise cash. Unfortunately, the IPO market is a lagging indicator when it's strong and a reactionary indicator when it's weak. Would-be public companies take advantage of good market conditions to maximize the money they might raise. Many companies, and their investment bankers, are also quick to wait when stock market conditions get weak. Therefore, the strength or weakness of the IPO market does not provide much of a signal for where stock prices are headed.

In terms of individual IPOs, it is critical to evaluate each one separately. For example, recent IPO companies GNC Holdings (NYSE:GNC) and HCA Holdings (NYSE:HCA) both have high levels of debt. Zipcar (ZIP), another recent IPO, has yet to turn a profit. Though there will be some IPOs of companies with great fundamentals, many successful IPOs are often higher-risk investments.

As far as participating in an IPO, check with your broker. Some online brokers have relationships with investment banking firms. Full-service brokers are another option, but relationships within the firm itself matter. Furthermore, since there are usually a small number of shares being sold, even if you are allocated stock in an IPO, the actual size of your holdings may not be large enough to justify the time and effort. The alternative is to buy the stock after it has gone public, which gives you more control, the option to buy more shares, and more time to evaluate the company.

Evaluating a IPO: If you are looking at an IPO or a company that recently went public, you should read through its S-1 filing, the prospectus companies must file with the Securities and Exchange Commission. You particularly want to look at the most recent S-1 or S-1/A filing, which will contain updated information. (The “A” stands for amended.) Regulatory filings for all public companies can be accessed through the SEC's EDGAR database.

Once you call up the prospectus, you should pay attention to the risk factors, how the company intends to use its proceeds, the financial data, business and industry conditions and the underwriters. John Deysher provided a thorough list of what to look for and how to evaluate the data in his AAII Journal article, The IPO Prospectus: How to Read the Fine Print.

The Week Ahead

More than 100 S&P 500 member companies will report earnings next week. The only Dow component included in this group is Kraft Foods (KFT), which will report on Thursday.

The week's first economic reports will be the April ISM manufacturing index and March construction spending. Both will be published on Monday. Tuesday will feature March factory orders and April motor vehicle sales. The April ISM services index and the April ADP employment report will be published on Wednesday. Thursday will feature the initial estimate of first-quarter productivity. April employment data (including the change in nonfarm payrolls and the unemployment rate) as well as March consumer credit will be published on Friday.

Boston Federal Reserve Bank President Eric Rosengren, San Francisco Federal Reserve Bank President John Williams, and Atlanta Federal Reserve Bank President Dennis Lockhart will speak publicly on Wednesday. Federal Reserve Chairman Ben Bernanke and Minneapolis Federal Reserve Bank President Narayana Kocherlakota will speak publicly on Thursday.

Charles Rotblut, CFA is a vice president with AAII and editor of the AAII Journal.