Decrease in IPOs is a Good Signal

Closing out the year, IPOs are back in the news.  There were several large IPOs in HK and the US in the last quarter of 2013 and many had good first day price increases.  Some press articles are expecting IPO activity to increase in 2014 with many calling for it to be the best year for IPOs since 2007 (articles here and here).  

A large number of IPOs always seemed like the sign of a market top to me.  But this has been more of an assumption than something based on fact or past performance.

Thanks to accounting firm Ernst and Young and index provider MSCI I was able to assemble the chart below.  It shows IPO capital raised and overall global equity performance as tracked by the MSCI All Country World Index (ACWI) for the past 11+ years.  Not a large sample at all, but better than nothing.

Bear in mind that these are quick and dirty numbers and not a strict apples-to-apples comparison.  Ernst and Young's IPO figures include several markets that are not included in the AWCI index such as Argentina, Columbia, Syria and Ukraine.  

However all of the large markets are included in both - the US, UK, Japan, China, etc. The US accounts for close to 50% of the MSCI ACWI and it has been the largest issuer of IPO equities in two of the last three years. “It is better to be roughly right than precisely wrong”, John Maynard Keynes is believed to have said.

The quick and dirty comparison shows that in the past eleven years, the global index increased every year after IPO raised capital decreased.  In other words, a good time to invest would have been the year after the amount of money that went into IPOs decreased.  This is highlighted by the red arrows in the chart below.  

However the reverse does not seem to hold.  In the six years that more money went into IPOs, the global index increased in four of those years and decreased in two.  

Thus my initial assumption was wrong.  A large increase in money raised by IPOs does not necessarily mean a market top.  If anything, I suspect that the amount of media attention surrounding new companies coming to the market likely generates more interest in the stock market which helps keep or push up prices and valuations.  

One additional observation.   For the last 12 years, there has mostly been a direct correlation between the direction of IPO capital raised and the direction of the index.  The only years the two were not in sync - at least during this time period - was 2003 and 2012.  In both years IPO funding decreased while the global market index increased.

US Version of Research Alpha

My research and investment methodology focuses on people, structure and valuation. I call it Research Alpha because it emphasizes factors that most analysts do not pay much attention to.

It can be lonely doing this as my methodology is not popular.  There are not many people to compare notes with.  Many investors don't believe or understand it. The majority of investors likely never thought about it.  

So it is nice to read an article that does a good job of articulating an investment focus that is close to mine.  It was written by Kristina Salen who is an ex-Fidelity/Oppenheimer/Merrill Lynch analyst.

According to the article, the author left finance and is now CFO of an interesting web-based business called Etsy.com.  The article looks at her previous investment role from the perspective of someone who is now on the other side of the fence.

The article I'm referring to was posted on the author's Linked-In website recently.  I became aware of it through the very good Quartz daily email.

The article seems like a US-centric version of my strategy.  In it, she notes three things that she learned about investing: strategy is important, people are important, and that forecasting quarterly earnings is mostly a waste of time.

The three factors she writes about are not one-for-one with my focus on people, structure and valuation; but they seem close enough to my past writings on Research Alpha and the importance of people to warrant a blog posting.

We agree on people.  Business is about people. They make all capital allocation and management decisions.  Understanding their background, their relationships and their past decisions can help investors determine if they are good or bad at allocating capital and managing a company.

We also agree that spending time on quarterly earnings is not very important.  I think of short-term earnings forecasts and what goes into them as Research Beta. There are many analysts making forecasts and these are quickly reflected in stock prices.  Trying to guesstimate next quarter's earnings feeds our emotional need for short-term results, but real wealth rarely comes quickly.

Where we differ is strategy.  Strategy is important, but to me structure is more important in emerging markets.  

By analyzing a conglomerate's structure one can identify the scope for leakages from a listed company into an unlisted entity owned by the same controlling shareholder(s). Minority shareholders get shafted if earnings, funds and management time and focus are transferred to other group owned companies.   

Strategy is likely more important in developed countries. In emerging markets the focus is on catching-up and transplanting business models, products and services that have already been successful. 

This brings up what I believe is the biggest difference of investing in the US and the rest of the world.  The difference is ownership structure.  In the US companies are primarily a single entity that has a distributed shareholding base.  They are typically not part of a conglomerate or 'group' as is the case in most of the rest of the world.  

Most investors don't look at the entire conglomerate and don't spend enough time looking at who owns and runs the entire business group.  I think this is a mistake. 

I've never heard of Kristina before I read the Quartz email.  Her article is insightful, well written and I'd encourage readers of this blog post to also read it.  

I'd also like to thank her for writing it.  My work is a little less lonely knowing that others look at the world somewhat similar to myself.  

Green Shoots in Greece

Some green shoots in Greece were reported yesterday.  The most significant is that the Greek economy shrank by 3.8% in the second quarter of 2013 compared to the year before.  This is not good, but better than the 4.6% that was initially expected.

As pointed out in the article, one of the reasons for the less-than-expected decline was an increase in tourism.  Revenue from tourism increased by 39% in the first five months of 2013 compared to last year.  A big factor here may not even have been Greece itself, but the unrest in Egypt.  But I suspect it is as much a change in the perception of Greece.

Typically most forecasts overshoot on the way up as well as on the way down.  This is prevalent in both macroeconomic as well as earnings forecasts.  I don't see why Greece would not fit this general trend and I suspect we will likely have more upward economic revisions in the future.

For me another statistic I think is much more important : Greece's ranking in the World Bank's Doing Business 2013 report.  This reports ranks countries on the ease of setting-up and keeping a small and medium business running.  Greece moved up 11 places from a rank of 89 to 78 - the largest increase of any developed market.

As several of my readers know I'm a big fan of Greece.  Especially its equity market, which despite its good performance, is still one of the least expensive in the world on some long-term valuation measures.

Please note that I'm biased.  One of the best weeks of my life was spent learning about the country, its stock market, and its listed companies.  The people I met in Athens last year are smart, switched-on and, from my very limited number of contacts, genuinely feel things need to change.  My write-up is here.