With the S&P 500 having recovered from its brief 'June Swoon' and now making new highs in July, sell siders are eagerly pushing new stock onto the market. The IPO window is open; at least by post 2008 standards. By the standards of the late 1990's, this IPO market would be considered only cracked-open or merely ajar; but by today's standards, the term open can be used. Clearly, this is a positive sign for the economy and the markets. IPO's create jobs and signal that growth prospects have improved. However, a flood of new stock from IPO's can also have a depressive effect on the market if the amount of supply of new equity exceeds the demand for it.
Indeed, one of the key drivers of the post 2008 bull market has been a reduction in the supply of stock on the market, which in turn was driven by the corporate refinancing boom amidst a low interest rate environment. With stronger balance sheets and lower interest burdens, corporations have been able to enact massive stock repurchase programs and buyout funds have been active in taking stock off the market through leveraged buyouts. Amplifying this trend even further has been M&A activity, as smaller cap stocks are taken off the market through the M&A process. If the new supply of IPO stock reverses this important bull market driver, then it could signal that a correction, or even a bear market, is just around the corner.
Other challenges facing emerging growth IPOs include valuation and quality of the offerings. One of last week's IPO's, a company called RetailMeNot Inc. (NASDAQ: SALE), is worth looking at as a barometer of both IPO valuation and price in the consumer space. RetailMeNot, Inc. is an online coupon and sale company that offers consumers special deals through its website. With a business model that is similar to Groupon (NASDAQ: GRPN) and scores of other online discounters, questions are raised about the ability of the company to differentiate itself from competitors. With a valuation of 700x trailing earnings per share at the IPO price of $21 per share, buyers are likely to be cautious on a valuation basis as well. Indeed, the stock chart of RetailMeNot may take a turn in the downward direction, just like Facebook (NASDAQ: FB) and Groupon , both of which declined from their IPO price and still have not recovered.
The take away lesson of the Facebook IPO is that even the highest quality IPO's can, and often do, become a bit over-hyped during the course of the initial offering. Apparently some investors forgot to review their notes on the Facebook IPO. RetailMeNot's successful offering at such a high valuation proves that the yearning for freshly minted stock still exists and that it has been amplified by the substantial reduction in the supply of equity during the past five years of post-recession market activity. In the long run, however, the stock of RetailMeNot is likely to face substantial headwinds as a result of overvaluation and competitive pressures in an economy that is still not creating jobs or consumer demand at a pace that can justify its IPO valuation.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.