Markets

Is the IPO Rush Signaling a Stock Market Top?

The stock market continued to gain ground on Tuesday, although as we've seen on numerous occasions, not all market benchmarks did equally well. The Dow Jones Industrial Average (DJINDICES: ^DJI) was barely able to gain any ground at all, while the S&P 500 (SNPINDEX: ^GSPC) managed only middling gains. But the Nasdaq Composite (NASDAQINDEX: ^IXIC) led the way higher with a strong advance.

Index

Percentage Change

Point Change

Dow Jones Industrials

+0.01%

+2

S&P 500

+0.52%

+18

Nasdaq Composite

+1.21%

+134

Data source: Yahoo! Finance.

Investors have been extremely excited about the IPO market lately, and tomorrow's anticipated first day of trading for cloud data warehousing company Snowflake has gotten a lot of hype. Moreover, other companies are finding different ways to come public, with particular emphasis on the use of special purpose acquisition companies.

Could this be a sign of a top? Some think so, but the answer isn't so clear.

Letters IPO spelled out in white mosaic tiles, with a yellow mosaic background.

Image source: Getty Images.

Snowflakes in September

Initial public offerings often generate a lot of hype, but the coming offering from Snowflake has gotten more than its fair share. Investor interest in the privately held company's IPO first ramped up when Berkshire Hathaway (NYSE: BRK.A) (NYSE: BRK.B) revealed that it would participate in the offering.

Since then, the appetite for it has been almost limitless. Snowflake had initially planned for an offering range of between $75 and $85 per share. But based on the reception that the company has gotten, it raised that pricing range earlier this week, all the way to $100 to $110.

That would put a valuation of as much as $30 billion on the company. That's more than 70 times what Snowflake has brought in as sales in the past 12 months.

Yet Snowflake has been growing so fast that even price-to-sales ratios start to lose their meaning. In the second quarter, revenue more than doubled from the year-earlier period. Existing clients are also ramping up their spending on the service. So what looks expensive now might not look so bad in just a couple of years.

Another SPAC deal

Some companies have sought to get out of the entire IPO process. They've instead chosen the alternative of a special purpose acquisition company, or SPAC.

That happened today with Social Capital Hedosophia Holdings II (NYSE: IPOB), whose shares soared more than 30%. The SPAC announced that it would acquire online real estate marketplace provider Opendoor, with the merger effectively allowing Opendoor to come public.

The move makes it simpler for Opendoor, but the deal gets complicated for investors. The SPAC will only contribute about $414 million toward the merger, with institutional investors adding another $600 million. All told, the deal will value Opendoor at $4.8 billion.

IPOs are a good thing

It's important to remember that not so long ago, investors were bemoaning the fact that not enough companies were doing IPOs. Sure, when times are good, more companies are willing to tap the public capital markets at healthy valuations. But that in itself isn't a sign that the market's about to crash.

Most of all, each IPO is different. Some companies might be too richly priced, while others might be bargains. The secret of investing is looking past the hype to figure out which companies coming public are worth the price you'll pay for shares.

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Dan Caplinger owns shares of Berkshire Hathaway (B shares). The Motley Fool owns shares of and recommends Berkshire Hathaway (B shares). The Motley Fool owns shares of Social Capital Hedosophia Holdings II and recommends the following options: long January 2021 $200 calls on Berkshire Hathaway (B shares), short January 2021 $200 puts on Berkshire Hathaway (B shares), and short September 2020 $200 calls on Berkshire Hathaway (B shares). The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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