Year of the IPO: Better to catch a ride on a unicorn than to invest in one

December 16, 2019 James Virgo

As the Year of the Pig winds down in Chinese astrology, some investors may look wistfully on 2019 as the Year of the Unicorn.

Mythical tech creatures like Uber, Lyft and Slack took to the skies to go public for the first time, only to see stock prices fizzle like falling stars. All three of those companies saw their prices go down at a time when the U.S. market has been very good overall. As of the end of November, Uber fell 34%, Lyft 32%, and Slack 12% from their initial public offering (IPO) prices (US$45, US$72 and US$26 respectively).

Beware the unicorns you know: what could go wrong?

A term popularly used to describe privately held startups with valuations of US$1 billion or more, this year's high-profile unicorns brought their initial public offerings to market, only to see values drop precipitously post-IPO.

In addition to the well-known ride-hailing services and social media sites, this year's IPO herd included other familiar names such as Pinterest and Peloton. Another publicity-friendly unicorn, WeWork, scrapped its own plans to go public in August, and now faces a very uncertain financial future.

Looking back on the year, it's a great lesson in why betting on the next great company can be risky business, and why traditional fundamentals still matter when valuing and selecting investments.

Not so simple to 'invest in what you know'

While you might feel familiar with companies you use for ride-sharing or social media, there's a limit to that old market adage to "invest in what you know."

Popularity does not always equate to profitability, as the current crop of unicorn IPOs illustrates. Even with well-known brands, you can't set aside fundamental analysis. An attractive company still has to have cash flow, a competitive business model, and an expectation of profitability in the immediate future.

This year, we saw several companies clearly come to market at much higher valuations than they should have; they've since lost value, despite the fact that the general market is positive to date

We set our hype-meter to high

WeWork's shelved IPO described the company's goal as to "elevate the world's consciousness." Peloton, the company that makes bikes and treadmills connected to the Internet, asserted in its IPO filing that it "sells happiness." I don't know about you, but happiness doesn't tend to pay the bills.

We saw this kind of hype before in the late 1990s, during the rise of the World Wide Web and the dot.com start-ups. While this gave birth to the Amazons and eBays of the world, those companies didn't make money initially. It took time to see profits and reinvest for future growth. For every success, hundreds of companies who raised public capital didn't make it. Either their business model wasn't sound, or the fundamentals just weren't there.

You don't always need to be there first to profit

IPOs can be a good way to participate early on in promising companies, but it's important to conduct due diligence and weigh associated risks. As an organization, MD is certainly open to participate in IPOs at the right price, assuming the fundamental basis for any investment is there.

However, this year's crop of headline-grabbing unicorns looked to us largely unproven and leaning more to hype than reality at this point.

Day one isn't always the ideal moment to invest in a publicly traded company. You can wait until fundamentals improve and invest later. Alternatively, private equity pools can be an alternative way to gain early exposure to companies not yet publicly owned or traded on a stock exchange, relying on professional management to identify winners and losers.

By all means, catch a ride on unicorn—just be cautious about including these creatures in your portfolio while their fundamentals are mythical.

About the Author

James Virgo

James Virgo, CFA, CFP, MBA, was Vice President and National Lead with MD Private Investment Counsel at MD Financial Management. He oversaw the practice of investment counselling and delivery of investment advice across MD PIC.

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