Consumer IPOs crush investors who 'buy what they know'
“Love the store, bought the stock” has been one of the lousiest investment strategies of the past year.
The new shipment of consumer initial public offerings that began arriving since last summer featured an array of popular retail and restaurant brands well known to small investors, including housewares chain The Container Store Group Inc. (TCS) and deli operator Potbelly Corp. (PBPB).
Nearly all the nine such Main Street companies came to Wall Street since late June 2013 with a ready-made audience of potential stock buyers. Most opened for trading at levels significantly above the IPO price paid by the select few professional investors awarded shares by the deal underwriters.
Yet in most cases, the stocks have suffered steep declines from the first-day price, where the typical investor could have bought shares. And in eight out of the nine cases, an investor would have been better off sliding cash into a Standard & Poor’s 500 index fund than grabbing for these hot brand-name IPOs.
Both Container Store and PotBelly slammed investors with news of poor quarterly results in the past two days, and the Street lost whatever patience remained, dropping Container Store shares by 11% and Potbelly by more than 20%. Both these stocks debuted last fall and the stocks first traded at double their IPO price. Since that first trade, they are down 30% and 61%, respectively.
This is more the rule than the exception for the 2013-’14 crop of newly public consumer names, which in addition to Container Store and Potbelly includes Noodles & Co. (NDLS), Sprouts Farmers Market Inc. (SFM), Zulilly Inc. (ZU), Zoe’s Kitchen Inc. (ZOES), Sportsman’s Warehouse Holdings (SPWH), Papa Murphy’s Holdings (FRSH) and Michael’s Cos. (MIK).
Taken together, the stocks on average are up some 24% form their IPO issue price. But measured from the stocks’ opening price on their first day of trading – the earliest the vast majority of investors could get in – the stocks are down an average of 18%.
The only stock of the nine that outperformed the S&P 500 from its opening price is Mediterranean casual dining chain Zoe’s Kitchen - a well-positioned concept expanding from its regional base in Texas - which is up 14% since its April 17 trading debut versus an 8% rise in the broad market.
There are a few important drivers of how poorly these consumer IPOs have treated investors, even aside from the standard heightened risk of buying into any company that’s untested by the public markets.
Retail and restaurant stocks in general have had a rough time in the past year. The consumer sector was a leader of the early phase of this bull market, but decelerating sales trends and mounting evidence that online “category killers” are wounding physical stores has weighed on “shopping stocks.”
The SPDR S&P Retail ETF (XRT) and the Nasdaq U.S. Small Cap Retail sector index have both lagged the S&P 500 by more than 10 percentage points over the past 12 months.
An overheated market
The back half of 2013 featured an overheated IPO market that prompted a stampede of companies to dress up their numbers and hone their growth stories, to capitalize on surging demand for hot new stocks four years into the market uptrend.
The Container Store and Potbelly, for instance, were both private companies for more than 30 years, successfully steady over the course of many cycles; they nonetheless marketed themselves to investors as compelling growth concepts of the moment.
Being a public retail company is tough, and managing expectations for same-store sales trends is a hazardous exercise even for seasoned chains. Both companies clearly got too aggressive and fell short of what investors were promised in the short term. Kip Tindell, CEO of Container Store, found himself blaming a pervasive “retail funk” as an explanation for its shortfall, never welcome words to Wall Street ears.
Then there’s Papa Murphy’s, seller of uncooked pizzas, whose private-equity owners seemed to have gunned growth through aggressive franchise expansion. It now finds itself under attack from franchisees for allegedly making misleading financial promises. (Yahoo Finance was skeptical of the company's valuation prior to its debut.)
A broader issue
A broader issue is worth noting: Well-known consumer brands that ordinary investors know and love from their local strip malls can produce an extra source of uncritical demand for their stocks when they become available.
Not many retail investors might have a strong view of the prospects for some new enterprise-software upstart or a reinsurance firm that’s raising capital in an IPO. But lots of investors who welcomed the new Noodles & Co. location in town or eagerly await the Zulilly daily-deal offerings in their inbox think they know something about the quality and outlook for those businesses. Interest from such investors on Day One can lift the stock’s initial valuation enough that it makes it tough for the company to substantiate it in the short term with its operating results.
The justifiably celebrated Fidelity fund manager Peter Lynch is identified with the idea of using one’s everyday economic interactions as a cue for investing decisions. But he only ever suggested using these real-world observations as a starting point.
Sure, it can be smart to “buy what you know.” But over time it’s far more important to know what you’re buying, and what it’s truly worth – based on hard numbers and sober expectations.
