- Beyond Meat’s IPO is a classic example of the mania that can surround an initial public offering.
- Many IPOs jump to a fast start out of the blocks, but typically end up under-performing over longer time frames.
- Psychology provides explanations for the irrational exuberance for IPOs.
“Most initial public offerings underperform the stock market as a whole. And if you buy the new issue after it begins trading, usually at a higher price, you are even more certain to lose. Investors would be well advised to treat new issues with a healthy dose of skepticism.”
– Burton Malkiel, economist, professor and author of “A Random Walk Down Wall Street”, a classic of financial literature.
Beyond Meat is the Los Angeles-based producer of vegan meat substitutes founded in 2009 by Ethan Brown. The company has developed plant-based products intended as an alternative to chicken, beef, and pork. Customers include Whole Foods, TGIF, Carl’s Jr., and Red Robin Food chains. Beyond Meat hopes to become the market leader in the alternative-meat category, which is expected to become a multi-billion-dollar market over time and take a significant share of the $1.4 trillion global market for meat.
But there’s a glitch. Beyond Meat has numerous competitors and has never made a profit. Nonetheless, its initial public offering was a huge success. The IPO offered to sell 9.5 million shares at $23 to $25. To say the stock took off from there is a gross understatement.
On May 2nd, Beyond Meat’s stock began trading on the Nasdaq under the symbol BYND. The first trade was executed at $46 a share. By the end of the day, BYND was trading at $65.75, or 163% above its IPO price. By June 10th, the stock had soared further, rising nearly 600% over its initial offering.
By June 11th, reality began to take hold. Beyond Meat’s share price fell by 25% following a downgrade by J.P. Morgan from “Buy” to “Neutral”. In a note to clients, J.P. Morgan analyst Ken Goldman warned the stock is “beyond our price target”. On Wednesday, Bernstein also downgraded the stock from “Market Outperform” to “Market Perform”, saying the stock had “limited upside potential from a valuation perspective”. By the end of the day Wednesday, there wasn’t a single “Buy” recommendation on the stock.
Despite the dram, irrational exuberance for IPOs is common. Unfortunately, not all IPOs have a happy ending. Some of the most infamous IPOs include:
- Pets.com’s IPO raised $82.5 million only to close its doors less than a year later.
- CIT Group was founded in 1908. Its 1997 IPO raised over $850 million. In 2009, the company filed for bankruptcy protection.
- In their first year of being traded publicly, Groupon’s stock price declined by 85%.
Academic studies regularly show that on average IPOs tend to underperform the overall market once the initial mania surrounding the IPO settles down. For example, Jay Ritter, a professor at the University of Florida who has done extensive research on IPOs, has found that while IPOs tend to start off with a bang, over the next 3-year period they tend to lag the overall market.
Given the challenged history, why do so many investors clamor to invest in IPOs? Behavioral economists may have the answer.
As I discussed in this earlier post, evolution has hard-wired certain behaviors or tendencies (cognitive biases in academic-speak) into our brains. Some of these biases offer an explanation for the love given to so many unworthy IPOs.
One example: representativeness bias, which refers to the tendency for good outcomes to garner more attention than bad ones. For example, while there has been a great deal of attention given to Beyond Meat’s IPO, far less has been paid to security provider ADT’s 2018 IPO flop. ADT’s IPO was supposed to price between $17 and $19 per share, but the stock ended up at $14, and at the time of this writing is trading at $6.50 a share. Investors who know only one side of the story regarding successful IPOs can have an overly favorable impression of them.
A second is hindsight bias, which refers to the natural tendency to believe in hindsight that an unpredictable event was predictable and completely obvious at the time it occurred. Also referred to as the “I-knew-it-all-along” effect, hindsight bias can cause investors to feel foolish for “missing out” on an IPO that proved to be profitable for early investors, without due regard for the risk of loss that existed when the IPO was launched. Such selective memories can lead to an irrationally strong desire to invest in future IPOs.
Another bias is the bandwagon effect. As its name implies, this is the tendency to believe in something (such as an IPO) simply because many others do. In other words, if an IPO is in high demand, it’s got to be a good deal.
Venture capitalist Aileen Lee coined the term “unicorn” to refer to a privately-owned start-up that beats the odds and is valued at over a billion dollars by its IPO. While searching for unicorns might be a worthy pursuit for speculators, prospectors, and day traders, I believe investors with a longer-term investment horizon are better served by utilizing a logical, intelligent and systematic approach to portfolio management.
Back in 1984, Wendy’s launched a humorous and highly successful commercial campaign to promote the beef in its burgers. You can see the first of the commercials here, and my personal favorite of the series here. What’s true for hamburgers is true for investing, at least if you’re searching for something other than fluff. In short, before you invest, don’t forget to ask: Where’s the beef?
Thank you for reading,
Mr. Market Commentator