Money Losing IPOs - Percentage Hits A Record High

Money Losing IPOs - Stocks Fall On Wednesday

The healthcare sector brought down the overall market on Wednesday. Heading into trading on Wednesday, the market had been up 12 out of the previous 14 days. It didn’t have enough momentum to cross the finish line that is the September all-time high. Therefore, S&P 500 fell 0.23%, Nasdaq fell 5 basis points, and Russell 2000 fell 0.96%. Even though VIX increased 3.45% to 12.60, CNN fear and greed index increased 1 point to 71.

It’s clear, my expectation for the market to reach a record high this week won’t be realized. As you can see from the chart below, the dumb money confidence indicator, which measures retail investor sentiment, is near its cycle high. The market might run out of gas before reaching a new record. If stocks fall, I won’t support the double top calls because leading indicators are turning higher.  

Money Losing IPOs - It’s IPO Central

After Lyft’s failed IPO, businesses are still planning new ones as Zoom, the video conferencing firm, is being valued at $9.2 billion and Pinterest, the social media firm, is being valued at $10 billion. The biggest of the bunch will be Uber later this year. 

These big IPOs are a signal the market is getting overheated. IPOs are timed based on the market as firms don’t want to raise money when there is volatility. These major IPOs take capital away from other stocks. It’s possible that if the other IPOs suffer the same fate as Lyft, overall market sentiment will turn.

Or maybe companies that don’t earn money just need to stop going public. 

As you can see from the chart below, the percentage of IPOs with EPS less than 0 is higher than the peak in the late 1990s. You can’t use Amazon as justification because Amazon created a whole new business that was immensely profitable (Amazon Web Services). Lyft and Uber won’t do the same. 

If private investors and venture capitalists see the IPO market drying up, they will invest less into money losing startups. That could hurt economic growth and the labor market.

Money Losing IPOs - Sector Analysis: Healthcare Falls Again

Healthcare sold off so hard that the entire market fell. On the positive side, healthcare will likely rebound soon. On the negative side, this means almost every other sector is extremely overbought. 2 worst sectors on Wednesday were real estate and healthcare as they fell 0.99% and 2.89%. The healthcare sector is down 7.71% since March 1st. It is only up 0.68% year to date. 

You can see in the chart below HCA Healthcare and UnitedHealth are two of the biggest losers in the group.

Even though many leftist Democrats have been calling for Medicare for All for a few years, investors have just caught on to the possibility of it being passed. The market has gone from ignoring a potential risk to overrepresenting the chance of it occurring. This selloff is overdone. 

Latest presidential poll has the moderate Joe Biden 8 points ahead of Sanders. More importantly, only 16 Democratic Senators support Medicare for All which means it has much less of chance of passing than the GOP’s healthcare reform bill did in 2017.

Money Losing IPOs - A Solid Earnings Season

Even though the market fell, 6 out of 11 sectors rose. That’s because the winning sectors had modest gains and healthcare was down so much. The 2 biggest winners were technology and consumer staples which rose 0.58% and 0.36%. Most of the market was up despite being overbought because earnings season has been solid. 

As you can see from the chart below, from April 1st to April 16th Q2 earnings growth estimates fell from 2.04% to 1.78%. That tells us how strong guidance was. Keep in mind, estimates almost always fall. When they fall by less than average, it’s a good sign. Last quarter was terrible.

As you can see, estimates for Q1 earnings growth fell from 5.54% at the start of the year to 0.07% on March 1st. With earnings season picking up, expect the blended earnings growth rate for Q1 to start to increase because most firms are beating estimates. 

Earnings Scout’s numbers will show positive earnings growth by the end of earnings season, while FactSet will probably show a small single digit decline. At this point in the quarter, I’m mostly concerned with Q2 estimates which means whether growth is positive or negative in Q1 is immaterial to my viewpoint on the market.

Money Losing IPOs - Solid Earnings Scorecard

I love seeing the earnings scorecard early in earnings season because it’s the best signal on how corporate profit growth will look next quarter. Estimated decline in the first 2 months of 2019 was likely overkill as estimates are being soundly beaten so far this quarter. 

As you can see from the top of the table, the first 42 S&P 500 firms to report earnings have EPS growth of 4.18%. That’s because they have beaten estimates by an average of 6.69%. Average surprise in the past 3 years at this point in the quarter is 4.25%. 

In what was supposed to be a terrible earnings season, estimates are being soundly beaten. This situation isn’t as bad as the 2014-2016 earnings recession. Stocks shouldn’t have fallen 20% late last year.

83% of firms beat EPS estimates which is 5% above the 3 year average. Sales expectations were much higher than EPS estimates heading into the quarter as analysts expected margins to decline. 

As the middle of the table shows, sales growth is 4.11% with the average surprise rate being 0.65%. 51% of firms beat these estimates.

Money Losing IPOs - Conclusion

Stocks are overbought and are very close to record highs. The bad news is IPOs of companies that don’t make money are prevalent. 

Good news is the first 42 firms to report earnings have mostly beaten EPS estimates. I expect similar solid results for the rest of the firms in the next few weeks. I’m most interested in tech which has -5.5% EPS growth so far.

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