Well, gosh: it turns out that if you value a company at 100 times its underlying earnings, investors avoid it like the plague. Shares in newly IPO’d companies like Just Eat, Boohoo and AO World all fell yesterday - Just Eat, which started trading last Thursday, fell 5.3% to 250p, 10p lower than the price it floated at, AO World dropped 5.1% to 280p (it listed at 285p), while Boohoo fell 4.3% to 49.7p (it floated at 50p). Here's what they've looked like over the past five days (four days in Boohoo and Just Eat's cases):
Source: Yahoo Finance
So what’s the problem? Have the scales finally fallen from investors’ eyes? Have they realised eye-watering valuations probably aren’t reflective of how companies will perform over the long term?
Two things are going wrong with newly-IPO’d companies. Firstly, banks’ clamour to advise them when they list means valuations are getting ridiculous. After a long dry spell on the IPO front, banks are in such fierce competition to get a good IPO in the bag that they promise higher and higher valuations. Businesses, obviously, go with the bank that reckons it can get the highest. It's a bit like when estate agents promise you they can get a high price - all they want is the commission.
Secondly, the other businesses banks are comparing relatively young companies with are well-established titans of their industry. As Michael Hewson, chief market analyst at CMC Markets, pointed out, ‘Just Eat was priced at a premium to Dominos, an established franchise that delivers and makes the pizzas and has revenues of £269m. Just Eat by comparison is a yellow pages for local takeaways where there is no quality control and no intellectual property and made significantly less revenues of £96.8m.’
Strong words, but a reasonable point.