Wealth Intelligence

Risk returns to the ASX. Beware!

Key points

  • The 'bull market' is now 8.8 years long

  • The end of a bull market is often indicated by an increase in IPOs

  • There is a current surge in IPOs on the ASX at inflated valuations

Risk returns to markets.  Beware!

The price of equities (i.e. shares or stocks) has risen fairly steadily from the GFC low in March 2009.  And now counts as one of the longest bull markets [1] in equities’ history (at 8.8 years and counting).  

This is shown in equity markets globally now trading well above long term average valuations: US S&P500 is trading on a PE of 25.6: 64% above its (147 year) average; Australia is not so affected, trading at 15.8; 8% above its long term average.

But a key ingredient marking a return to gratuit et facile days [2] has been missing. 

Until recently.

IPO boom

In the past 7 years, the ASX has had on average 80 IPOs (i.e. Initial Public Offerings, or ‘floats’: companies being listed on the ASX for the first time) each year.  In 2017 the ASX is on track for 128 IPOs: a 36% increase on IPOs in 2016 and 60% higher than the 7-year average.

WI 2017 IPOs

This increase in IPOs has accelerated as the year has progressed, with 32 IPOs in the past six weeks alone, and a further 10 expected before the end of December.

This run of IPOs has been incredibly successful, and shows how welcoming the market is to new issues.

IPO runs tend to build on themselves and the returns offered by IPOs has steadily built from -0.2% 'extra' above market return (from new issues in 2012) to the +11.5% return from the 2016 grouping.

Floats such as Moelis (a financial services group) earlier this year priced at $2.35 at IPO and trading today at $6.27 (and a P/E of 36.9; i.e. a price 36.9 times the expected FY-18 profit) have built the 'excitement' around the instant rewards on offer (Moelis' share price rose 34% on its first trading day) from IPOs, such that the nature of the issues becomes less exciting than the issue itself. 

Carefree days 

On First Samuel estimates, 75% of the companies that had IPOs in the past two months have no history of profit and are either newish projects (resources), medical trials (at testing stage) or technology/Fin-tech with no clear path to medium term profitability (in our opinion).  These may or may not be great businesses, but the probability of success is usually low, very low.

The other 25% of the issuing companies are expected to be profitable in FY-18 (and therefore of more interest!).  The telling feature is the initial price of these profitable IPOs and how they have subsequently performed. 

These 8 issues (with a cumulative market value of $5.1 billion) have been incredibly well received with a first day investment return of +20.9% on average. Since listing they have returned on average a total of +24.7%. On our analysis, this marks the most successful listing run in a decade.

Whilst these type of short-term returns can happen when assets are lowly priced (in order to encourage people to invest – a guaranteed return almost upfront), the fact is the initial pricing for these IPOs was on a PE of 22 (i.e. 22 times the expected FY-18 profit) on average (so a start to life some 39% above the average of already listed companies).  Moreover, the market has further increased this pricing to a P/E of 24.4 since listing (and to 36.2 if you weight the average by the size of the companies!).

WI 2017 IPOs PEs

Of course there can be no denying that some of the recent listings have been good businesses. Behind most periods of overpricing and enthusiasm, there is always a good idea, business model or business (with the exception of Bitcoins and Tulips!). 

Indeed anything sounds reasonable when you are not worried about anything and money (and returns) are easy.  Which is the point of what the market is saying today.  There is nothing to worry about!

IPO market now 'jubilant'

This carefree approach to investing, be it in small unprofitable companies or very highly priced large companies has been a key missing signal that markets have in fact become overly jubilant. 

With these signals now present, we therefore enter 2018 with both eyes wide open.

We are making sure we keep a clear and steady focus on only investing where prices are reasonable and good returns therefore likely.

The outcome of this is that we may miss out on some of the day-to-day excitement.  But we will not rely on the short-term emotion of the markets to dictate our clients' long-term wealth opportunity. 

[1] A ‘bull market’ is one where stock prices are rising for a long period.  There is no actual definition, but some suggest it’s where the market hasn’t fallen peak to trough by more than 20% before a 20% rise.  The ASX came close in the 5 months to September 2011 (-19%) and the 11 months to February 2016 (-18%).  A bull market compares with a ‘bear market’ – a long period of prices falling.

[2] Free and easy.

  -  Dennison Hambling, CIO