Apr 3, 2019

Sky-high IPO valuations inspire housing crisis flashbacks

Dion Rabouin, author of Markets

Illustration: Aïda Amer/Axios

Stock market investors and huge pension plans in pursuit of boom-era returns are chasing just about anything with a growth story, regardless of whether the underlying company actually makes any money.

Why it matters: The market demand pushing up sky-high valuations for companies like Lyft, Uber, Airbnb and others is akin to the housing bubble in the early aughts, says Karl Dasher, CEO and co-head of fixed income at investment firm Schroders.

  • "The last time we saw that in fixed income was the housing crisis where within asset-backed securities, particularly sub-prime mortgages, there were built-in assumptions about price growth and ability to re-finance," Dasher told Axios during a media reception at the company's headquarters.

The big picture: Last year 81% of American companies were unprofitable in the year leading up to their public offerings, according to data from Jay Ritter, a University of Florida finance professor.

  • The unprofitable companies are so far outperforming the profitable ones— with median returns of 120% on an annualized basis from their IPO price vs 57% for companies that generated a profit.

Between the lines: This latest iteration of investor FOMO ("fear of missing out") has its roots in the Great Recession and the U.S. response to it.

  • The financial crisis drained Americans' home equity and life savings, and it put fund managers overseeing the $27.1 trillion currently in U.S. retirement savings well behind their expected return totals.
  • Quantitative easing was the response. Sold as a palliative to get credit to distressed Main Street homeowners and businesses, the biggest impact of the Fed buying up Treasury bonds to flood the economy with cash was a burst of mega-mergers and the stock market rising to all-time highs.
  • That flood of cash also pushed bond yields to near zero. With stocks booming, investors began moving out of safe-haven bonds and cash holdings and into stocks and alternative assets, starting in 2009.
  • Investors who have taken more risk have been rewarded with higher returns, meaning more clients and higher income. So more investors have followed.
  • And so-called growth stocks have trounced value stocks since the crisis. An index tracking growth stocks — those with high prices compared to the amount of money they're earning — has delivered a cumulative return more than 100% better than the corresponding value stock index from 2007 to 2018.

The bottom line: Companies like Lyft will continue to find a bid as long as they can convince investors of their growth story — at least until there's a crisis or something that changes the current market environment.

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