3 reasons we're not in an IPO bubble

It's OK to warm up to the new-issues pipeline.

By Motley Fool Pick of the Day Apr 10, 2012 2:26PM
By Rick Aristotle Munarriz

 

Everybody's picking on the new kids these days.

 

"A new-issues craze is always the last stage of a dangerous boom," John Rothchild once wrote in The Davis Dynasty, and that sentiment was echoed by WhopperInvestments.com yesterday in calling out the recent market enthusiasm for IPOs.

 

The pipeline is certainly gushing these days. As many as eight companies are angling to go public this week alone. So?

 

Let's go over a few reasons why we're not in an IPO bubble right now.

 

1. A hot IPO or two isn't a sign of the apocalypse
Things may have seemed frothy two weeks ago, when Annie's (BNNY) soared 90% on its first day of trading. The organic foodstuffs maker's pop was the biggest move that the market had seen since LinkedIn's introduction 10 months earlier.

 

That record stood for exactly one trading day. Mobile marketing speedster Millennial Media (MM) catapulted 92% higher when it began trading the following day. Did underwriters underestimate the value of these deals during the pricing process? Are speculative retail investors ignoring the institutional supply and demand that factors into the original price tag?

 

A pair of hot IPOs on back-to-back days may seem toppy, but these also weren't bad companies. Annie's is a darling among organic edibles, as its flagship mac and cheese, snacks, and rising dough pizza are grocery staples even at non-organic establishments. Millennial Media is the second-largest player in the booming mobile advertising market after overtaking the world's most valuable company. Revenue more than doubled at Millennial last year.

 

More to the point, neither IPO managed the 109% surge that the work-centric social networking website operator scored last May. If a big IPO pop is a sign that the party's over, why is the market still rolling 11 months later? The market may have corrected in the months following LinkedIn's IPO, but the tech-heavy Nasdaq is now trading 8% higher than it was the day LinkedIn hit the market.

 

2. The wannabes aren't here yet
A surefire sign of a bubble is when the copycats and pretenders begin going public. From profitless Internet companies during the dot-com bubble to second-tier casual dining steakhouses in the 1990s to the mad scramble of obscure Chinese growth stocks just a couple of years ago, it's not a new-issues craze until underwriters send in the clones.

 

Is that happening these days? Annie's is the real deal. Millennial Media is the top dog in mobile marketing and isn't tied to a specific operating system.

 

You won't be getting a poor man's Facebook next month, because it will be the Facebook going public next month. It wasn't some castoff social gaming developer that went public in December. Zynga (ZNGA) -- an app maker so potent that it accounts for 12% of Facebook's revenue -- is the one that hit the market in December.

 

Pretenders are getting either weeded out in the underwriting process or flopping if they do make the cut.

 

3. Sanity prevails
We've seen a strong February and equally robust March, but things aren't as bubbly as you may think.

According to Thomson Reuters data, proceeds from stateside-listed IPOs fell 58% to $6.5 billion during the last three months, relative to last year's freshman quarter.

 

And the market itself isn't insanely valued, despite three years of generally rallying equity prices. According to Barron's, the S&P 500 is trading at 16 times trailing earnings. The benchmark has climbed just 5% higher over the past year, but it was trading at 17 times trailing earnings last year. How can the index climb and the P/E fall? Well, that's earnings growth at play, and most companies are expected to continue to grow their bottom lines this year and beyond.

 

The market may be coming off of strong back-to-back quarters, but a lot of that is just a matter of equity prices catching up to improving fundamentals. Don't blame the new kids; they're either pulling their weight or being exposed, and they're facing rational markdowns in the process.

 

Longtime Fool contributor Rick Munarriz calls them as he sees them. He does not own shares in any of the stocks in this story. Motley Fool newsletter services have recommended buying shares of LinkedIn. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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