A lot of companies have gone public this year. More than 140 at last count. Don’t panic.
For those of us old enough to remember when sock puppets sold dog food, an IPO surge tends to produce perspiration. Are we once again being sold shiny piles of garbage? Will it stink up the broader economy? And why exactly are so many companies going public at the same time (i.e., does something already smell, but we’re the last to know)?
A cursory look at the data seems to support such concerns. The best two years for new U.S. listings during the aughts were 2000 and 2007 — both were immediately followed by recessions. Now 2013 is on pace to become the next surge year, having already topped last year’s total.
But there’s no reason to believe the pattern is going to hold or that there really is a pattern to begin with. For starters, 2000 was a busier year for IPOs than 2007, but the 2001 recession was far less severe than 2008’s. In other words, more IPOs aren’t necessarily followed by more pain. Second, 2000 was the culmination of 10 straight years of 200-plus IPOs that actually peaked around the middle (1996), whereas 2007 was the height of its four-year era. Finally, IPO volume in 2013 has arguably been aided by last year’s bipartisan JOBS Act, which has resulted in more than 250 “confidential” registrations with the SEC.
In fact, the only thing that all IPO booms really share is that they occur during stock market increases, since few companies can stomach the risks of selling into a dip. Eventually the tide will turn and people will point to a particular IPO as being the proverbial canary, but it’s important we not mistake circumstance for causation. For example, there were numerous skeptics last year who suggested that Facebook’s IPO represented some sort of summit — before the broader markets ignored them and kept chugging along. LinkedIn’s IPO and soaring stock a year earlier inspired similar stories. Someone will probably finger Hilton Hotels later this year and, if the bears don’t materialize, the next big one to follow.
In the meantime, what we must do is decide whether this particular boom is riding on the backs of fundamentally weak or strong companies. If the former — as was true back in 2000 — then this year’s IPO volume would be cause to begin buying stock in fire-resistant mattress makers. If the latter — as was largely true in 2007, when the subsequent crash was caused by unrelated factors — then IPOs are just taking advantage of market conditions rather than abusing them.
As you may have guessed, I’m pretty bullish on the current crop, for two primary reasons: Performance: As of the time of this writing, there were 73 companies that had priced 2013 IPOs and also reported Q2 earnings. Standard & Poor’s reports that 38 of them (52%) beat Q2 earnings expectations, while three others met expectations (total of 56%). The figures are similar for Q1 earnings beats, albeit from a smaller sample. These companies aren’t just trading higher on investor demand for something new — they are producing tangible results.
Supply: Following Facebook’s troubled offering last year, there were questions as to what types of companies would be able to go public next. In fact, the experience was so scarring that not a single company ventured out for the next month. But what ultimately emerged was a spate of offerings for enterprise software companies that relied on secular megatrends like the cloud and mobile to add large corporate clients. Those aren’t about eventually finding a way to monetize eyeballs or clicks, or some other scheme that could easily collapse in the absence of GDP growth. Outside of tech, there have also been a number of private-equity-backed IPOs for mature companies that have already proven themselves as public entities in the past (albeit with less debt on their books).
Yes, the markets will eventually begin to slide. But it won’t be because 2013 was a banner year for IPOs. It will be in spite of it.
This story is from the September 16, 2013 issue of Fortune.
