Hype or Hope? Airbnb And The Pitfalls of IPO Investing
How to Navigate The Choppy Waters of IPO Investing
Hi Everyone,
My basic notion of pre-selecting stocks by fishing in the proper pond not only tells me which stocks to buy, but also which stocks to avoid. In a recent piece, I described a group of stocks that I avoid because they do not generate positive Free Cash Flow:
I frequently observe investors losing money on IPOs (Initial Public Offerings). These stocks are usually promoted by the financial media, and following the herd is rarely an effective approach for beating the benchmark or getting any results. When examining the annual number of IPOs, we observe that they overlap with market cycles.
The reasons for that are simple: Founders want to cash out for the best price after years of building their companies and during economic upswings the sentiment is simply better to go public at a higher valuation (remember, a high valuation increases the chances of a loss). Investors become careless and pay more than they should as new valuation metrics get invented:
Is it smart to buy a stock when the sellers’ goal is to sell it for the highest price possible? The level of IPO euphoria is an excellent indicator of where we are in the cycle. When a large number of companies go public simultaneously, you should avoid purchasing shares of them, especially on the first trading day.
Let’s take a look at the latest IPO bubble. Remember Wall Street’s darlings? Rivian RIVN 0.00%↑, Robinhood HOOD 0.00%↑, Snowflake SNOW 0.00%↑, Coinbase COIN 0.00%↑? How did investing in those former stars play out?
As you see, most of them crashed badly due to poor results that couldn’t keep up with the market’s expectations. This is not the exception, but the rule. Investors got burned in 2000/2001 in the same way.
Is staying completely away from IPOs the solution? I think a general mindset shift is necessary. Success in the stock market depends on being a generalist who sees the big picture. I don’t like to make mistakes, but at the same time, I know that human nature is prone to making mistakes.
Mistakes can be avoided easily by dividing stocks into what I call “Performance Groups” or “Fishing in the right pond”. Does a certain stock belong to groups that have historically outperformed?
Have IPOs as a group outperformed the market? No.
Have dividend growth stocks outperformed the market? Yes.
Have founder-led companies as a group outperformed the market? Yes.
And so on…
In case of doubt, investors should do what is often best: Waiting.
When the tide goes out you discover who’s been swimming naked. The two companies that catch the eye from the graphic above are Airbnb ABNB 0.00%↑ and Palantir PLTR 0.00%↑ because investors barely lost money on them after the IPO market cooled down.
Let's take a closer look at Airbnb because most readers should be familiar with it and because their business model is easy to understand.
Are they worth watching?
The stock recently caught my attention because the company had its first profitable year in history.
No matter how promising a business model is, if a company is not making a profit it’s not worth betting that one day it will (Wall Street operates the other way, profitability gets ignored as long as revenues rise - until reality sets in). It’s better to wait and see how things develop and play it safe.
Airbnb’s revenue is rising, more nights are booked each year and they are starting to become profitable. So far these are good signs. They have many complaints about high cleaning fees and bad customer support (especially in their home market, the U.S.), so it will be interesting to watch how their management navigates the coming quarters and if they stay profitable.
I keep them on my watchlist.
Not all IPOs are trash, but most of them are. And those which remain relevant after the boom cycle might become established players one day. Keep that in mind.
Until the next issue. 👋
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Disclaimer: This analysis is not advice to buy or sell this or any stock; it is just pointing out an objective observation of unique patterns that developed from my research. Nothing herein should be construed as an offer to buy or sell securities or to give individual investment advice.