Thursday, July 08, 2010

Lack of New IPO's and Impact on Performance

If you read typical finance articles out in popular media you commonly see facts and figures about how US stocks outperform other investment classes over "the long term".  As I do my own research I tend to see threads leading back to the premise that US stocks are entering a new environment going forward and past results are going to be less and less relevant in predicting future performance.  One of the reasons for this is the fact that the United States has ceased to be a dominant player in launching new public companies, and in fact is now mostly an also-ran when compared to Chinese markets or even Brazil as of late.

The Agricultural Bank of China is about to come out as an Initial Public Offering next week that will be one of the largest IPO's of all time.  Per this article:

Hong Kong and China have dominated the global IPO market. That dominance will only increase when Agricultural Bank of China starts publicly trading next week.  In 2009, Hong Kong was the world's largest IPO market, with companies raising a combined $32 billion in capital, according to Dealogic, a data-tracking firm. This year, China is on track to assume the mantle, with $31.7 billion raised by early July.
The Wall Street Journal had a recent article titled "How to Fix the IPO Market" by Jason Zweig.  I didn't agree with their analysis or recommendations but the article did have a lot of useful facts and figures that illuminate the changes in the public markets in the United States, such as the following:

Ten years ago, around 9,100 companies filed annual proxy statements with the Securities and Exchange Commission. Last year, roughly 6,450 did; so far in 2010, only about 4,100 have, estimates Wharton Research Data Services.  In two-thirds of the years from 1960 through 1996, the number of initial public offerings exceeded the number of stocks that dropped out. Since then, however, there have been more deaths than births among stocks every year: 7,725 stocks have disappeared over that period, while just 4,299 new ones have arisen to replace them, according to Wharton.
What is happening is that existing companies are swallowing up smaller companies and other ones went bust during the market tumult.  New companies, however, haven't joined them.  Recently there was a bit of a hoopla about a recent IPO for Tesla Motors, which raised $266M.  However, prospects for the car maker are cloudy and the stock has declined below its offering price since then.  If Tesla, a loss making niche enterprise is the future of our growth companies, we are in trouble.

The reason that this matters is that the entire "stocks outperform over the long run" is based on data from a few markets that haven't suffered major disruptions (war, occupation) which pretty much brings you down to US and UK market data, mostly US data.  And this data was based on a continuous growth in companies launched through IPO's with a growing market for companies; today the market for US based companies is small and much of the new and larger IPO's are happening overseas.

There is nothing wrong with overseas markets growing; it is just that the US markets seemed to have stopped, and investor money (both US and foreign based) is going where the IPO's are.  While we do not see the "full" effect of this trend, because many large multinationals are still US based and doing well, we will see it in the future as the newer companies don't fill in the gaps and come through the ranks at some point in the future.

This doesn't mean that I am saying that US markets will go up or go down as a result of this; I am just saying that the long term data was based on a premise that new companies would grow to replace the old ("creative destruction") but in fact the new companies aren't coming up in the footsteps. Perhaps stocks are best in the "long run" in aggregate across all markets but it may not be US based stocks if we just have aging companies and the young, growth companies are nurtured elsewhere.

Cross Posted at Chicago Boyz and Trust Funds for Kids

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