What Does Poor IPO Pricing Indicate About Sentiment?

What can we conclude about future market performance based on how successful or not IPOs are?

Mark Hulbert looks at that question in a column in the Sunday NYT.  He reviews a study that suggests all the recent IPO postponements/cancellations are "an indication of investor pessimism that may actually turn out to be bullish for the overall stock market."

"Worldwide in June, more companies withdrew or postponed their initial
public offerings than in any other month since March 2001, according to
Dealogic, a firm based in London that monitors the new-issue market.
That March 2001 trough came less than halfway through the 2000-2 bear
market, leading many investors to worry that the current gloom in the
new-issues market is a harbinger of much lower prices for stocks.

But the stock market’s continuing decline in the months after the March 2001 I.P.O. bust was probably an anomaly, says Jay R. Ritter, a finance professor at the University of Florida who specializes in I.P.O. research.

An analysis of initial offerings market since 1980 suggests that, all else being equal over the next 12 months, the market between now and the summer of 2007 is likely to produce above-average returns."

I am compelled to point to a few issues with Prof Ritter’s methodology. First, he analyzed the IPO market from 1980 – 2000. That period includes all of the 1982-2000 secular bull market and the 2 years that preceded it. It would be more representative of broader market history if the Prof had reviewed the data going back to 1966. That way, he would have had both a secular bull and bear market.

Secondly, Prof Ritter ignored the period that seems to not support his conclusion. If we are to consider the 2001 period an "anomaly," and disregard the parallel between then and now, than we must also consider whether the 1980 to 2000 period is anomalous as well. At the very least, we have to determine if it is representative of broader market history.

That time period — the strongest bull market in history — is suspect to use as the sole basis of comparison. Including a comparable bear period would  likely improve the study’s results.

All historical comparisons have flaws, but the more parallels you can draw between time periods for as many different variables, the more informative the comparison can be.


Undervalued IPOs


graphic courtesy of NYT


Its an interesting idea to use IPO pricing and other data points as the basis for forecasting. A broader historical period might have produced a data set that wecould have more confidence in.


If Initial Offerings Fall Short, Start Looking for Bulls
NYTimes, July 30, 2006

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  1. SINGER commented on Jul 30

    i tend to agree…what’s interesting is how populated people’s minds and statistics are with stories from that unprecedented bull market fro 82 to 2000…its just like certain money managers whose results you here about or who got rich etc…its not that i don’t give them props but for real how good of a stock picker etc did you need to be during that time to have good returns…

    i always have people telling me stories of even how good their 401k’s etc have been doing since 2003… i tell them thats because the dow just went from under 8k to over 11k… the problem is when the down periods occur

    da big pictcha a run tings…


  2. BDG123 commented on Jul 30

    You know my grass grew faster last week because it rained alot. I bet I can devise a correlation strategy around that. Do you think?

  3. abe commented on Jul 30

    You never know BD, some folks swear by Astrology. And Nancy is nowhere to be found…

  4. Kris commented on Jul 30

    At least one can say that fewer IPO issues mean less supply of equity in the public markets. To me the major issue with all this is timeframes. Investors are negative so I guess one can say that is bullish but the real estate market is the same way. Does that mean you should buy?

    I’ve just completed a survey of real estate in parts of MA and NY and the major increase in supply along with regular price decreases indicates a weakly bid market. There’s no way to know how long the market will stay this way and when it turns around from what level it will be moving up from.

    These falling asset prices suggest to me that the inflation threat will be gone soon enough although it may mean much slower growth ahead.

  5. mentalmodel commented on Jul 30

    all this is happening during a time of massive corporate buybacks, something that Ritter has written about in the past (covering short positions established via options grants and secondary offerings?).

  6. RW commented on Jul 30

    Corporate buybacks of stock: good for current stockholders, excellent for corporate officers, essentially meaningless for GDP and virtually everything else that really matters to an economy. There is no new wealth being created here, no capital creation; an economy that relies upon this is an economy that is going down.

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