Are Initial Offerings Overpriced?
Stock vs Cryptocurrency: a quantitative study of IPOs and ICOs
In 2018, the Initial Coin Offering (ICO) is definitely a buzz word. With many spectacular fails and regulatory rules, the ICO frenzies diminished dramatically toward the end of 2018.
On the other hand, after Q1 2019, with lots of high-profile Initial Public Offerings (IPO) like Lyft, Pinterest and Zoom, and even the 800-pound gorilla Uber, it seems IPOs are roaring back. Actually, it has been on a steady increase in the past 4~5 years. In fact, the IPO frenzy never diminished, just temporarily outshined by the ICOs temporarily in 2018.
As bad as they look?
With so many ICOs projects busted or zombified, one may wonder how bad they actually are. On the other end of the spectrum, we have also seen many high-profile unicorns that went public with outrageous evaluation, completely unprofitable for year, and also with enormous loss and skyrocketing price. How bad can those be?
A quantitative comparison
There are many ICO vs IPO comparison articles, and they usually make an itemized comparison of the two from several aspects, including legal, regulation, duration, target investors, eligibility, etc , without much data support.
In this article, however, we take a quantitative approach and collect recent data from IPOs and ICOs in the past few years and quantitatively measure whether they are reasonably priced or over-hyped, and hence determine whether they are good investments or not in general.
Collecting IPO data
We collect all the listed names on NYSE and NASDAQ, and download the price history for these names as our starting point for evaluation.
Caveat: Survivor Bias
It is true that we may not be able to collect some of the data points. For example, many of the 1999–2000 bubble IPOs no longer exist.
Therefore, to limit the negative impact of survivor bias, we limit this data collection approach to only recent years (8 years to be exact), where not so many IPO stocks in this economic cycle have gone bankrupt, to mitigate the survivor bias and its effect on our conclusion.
How to measure the return of a stock
For our purpose, we would like to know that at the moment of the IPO, whether the stocks are fairly priced.
We choose the one-quarter return of the stock price since the IPO date as our measure, because that includes exactly one public earnings report, where the company fundamentals will be under Wall Street scrutiny and hence reflected on the price return.
Using a shorter time interval may introduce more psychological swings, and using a longer time frame only introduces more noise of macro economy, company business changes, etc.
Collecting ICO data
Essentially we use an approach similar to IPO data collection. We employ the coingecko.com api to find a comprehensive list of cryptocurrencies (4000+ coins), and find the first date for each coin/token with a valid price. Using these dates as the IPO dates, we then collect the price history for each coin with one quarter looking ahead.
Interestingly, yet not surprisingly, many coins/tokens do not even have 90 days of price history, i.e. they got zeroed out within the first 90 days after their ICOs. But don’t haste to draw the conclusion yet. We shall see more details later.
Quantitative Comparison
Number of Initial Offering Cases
ICOs are much easier than IPOs, since they do not require as much financial qualifications and legal hassles. It it not surprising that we have much more ICOs in more than a year than what we have for IPOs in almost a decade.
Counterintuitively, the technology stocks are not the majorities of IPOs. Actually, health care, finance and consumer services accounted for most of the IPOs. This shows how much of a cognitive bias that we have by being bombarded by the mass media day in and day out.
An upcoming winter for IPO?
If we rescale the two plots above by time, approximately one-year in the IPO plot for three months in the ICO plot, we cannot help noticing the similarity in the shapes of the two plots: a long period of sluggish increase, with a sudden explosive in the number if initial offering cases, followed by a little stall, and then followed by an even more explosive frenzy.
The only difference is that we have observed the freezing winter for the ICOs, but not for the IPOs. Or, shall we say, not yet.
Distribution of One-Quarter Returns
As investors, this is what interests us the most:
Shall I invest in these initial offerings? If so, how?
First we compare the distribution of the one-quarter return by juxtaposing the cumulative distribution of the one-quarter returns of IPOs and ICOs. The shape of those cannot be more different:
For the IPOs, the distribution is a more “centered” one, with most of the returns center around breaking even. These means that most of the IPOs are actually very fairly priced. They do not have a lot of excessive returns on the up side, yet they do not have very bad returns either. If you invest in a few random IPO stocks (not just the high-profile ones), most likely you will break even.
On the other hand, for ICOs, the distribution is a more “left-skewed” one, with most of the returns leaning toward a big loss, and very few with astronomically large positive returns. This means that if you only invest in a few random ICOs with too much extra information, chances are that you will lose most of your money. Only when you invest on a much wider spectrum can you on average make more money, actually much more than the IPOs.
How to invest in IPOs and ICOs as a retail investor
Assuming that we can invest equal amount of money in all IPO cases and ICO cases shown above, then on average, we can make a lot more money in the ICO cases due to a few super stellar coins/tokens. But realistically, not everyone has enough capital or connections to be able to invest in thousands of ICOs. Therefore for the retail investors, be extremely cautious with ICOs, at least at current stage, is a wiser choice.
As for IPOs, they are not that interesting of a group to invest in, since statistically they are reasonably priced and the expected return in one quarter is simply around 0. If you are looking for some quick profit, maybe it is better to bet on something different. But if long-term growth on some specific area is what you are interested in, IPOs may not be bad ideas.
Conclusions
Historical data shows that IPOs (2010-today) are fairly priced and their one-quarter returns center around 0%. Meanwhile, data shows that ICO (2016-today) returns skew heavily on the negative side, with 80% of coins/tokens losing their value, and a few increasing dramatically. Investing directly into a small number of ICO tokens is not a sound strategy, statistically speaking.
In addition, in terms of the number of initial offering cases as a function of time, IPO and ICO are very similar. The fact that the ICO cases diminished dramatically after the 2018 frenzy may indicate an upcoming cool down for IPO cases, too.
About the Author: SophonTech Inc. is a technology-driven company that provides solutions to cryptocurrency software and quantitative research.
Contributor and Editorial Credit: H. Zheng
Legal Disclaimer: SophonTech Inc. is not an investment advisor, and makes no representation regarding the advisability of investing in any security, fund, token, derivatives, physical assets or any other investment vehicles. All SophonTech Inc. materials have been created solely for informational purposes based upon public information from sources generally believed to be reliable. The data and analysis demonstrated do not represent the results of actual trading/investing.
