Investing in an initial public offering (IPO) can be tricky. There’s often lots of hype, and it’s easy to get caught up in the emotion of the moment. After all, most companies look amazing in their registration documents…
That’s why it’s often better to wait a few quarters and evaluate a company’s performance in the public arena and perhaps take some of the emotion out of what can be an important investment decision. If a company truly has the potential to compound shareholders’ returns over the long haul, it will still be a good investment, even at a later date. By contrast, if I’m compelled to buy shares of an IPO to avoid missing out on all the upside, then I’m either thinking too short-term or it’s not that great an investment in the first place.
That’s the main reason why most IPOs don’t land in my portfolio. But they do occasionally land on my watch list. Three recent IPOs I’m watching are GoodRx Holdings (NASDAQ:GDRX), Peloton Interactive (NASDAQ:PTON), and Lemonade (NYSE:LMND). But remember: Investors should purposely watch the companies on their watch lists. Here’s why I believe these stocks belong on your watch list.
Great businesses simultaneously solve problems for multiple parties. In this way, GoodRx is a great business. Its app helps users find the lowest price for prescription drugs in their area, making treatments more affordable. Not only is this beneficial for users, but it’s also helpful for pharmacies because high-priced prescriptions are often left unpurchased, resulting in waste. Furthermore, doctors benefit since more of their patients will take their recommended medicine.
GoodRx could become a cash cow. In the first half of 2020, the company enjoyed a staggering 95% gross profit margin. Its biggest drags on the bottom line are sales and marketing expenses at 45% of revenue, but this is money well spent. Monthly active consumers grew at a 59% compound annual growth rate from the beginning of 2016 to the end of 2019, and 80% of all revenue currently comes from repeat customers. These factors lead me to believe that at some point, GoodRx will be able to dial back marketing spend and turn on the profits.
The stock has a sky-high valuation at 40 times trailing sales. Sales are quickly growing, with revenue up 48% year over year through the first half of 2020. But I’m not sure the growth rate justifies the price tag: If the price per share doesn’t move, it would take about 3.5 years of revenue growth at the current pace just to reach a price-to-sales valuation of 10. I admit stock valuations have soared this year in general, but there was a time when many investors believed even 10 times sales meant a stock was expensive.
When valuation is the only concern, that’s not a great reason not to buy; many of the best investments look overvalued at the time. But in the case of GoodRx, I have another concern. Its business primarily centers around prescription drugs, and prescription-drug pricing is a big political issue right now. Both presidential candidates are vowing reform, and it could potentially diminish the need for GoodRx’s services. Therefore, this is a rare case where I would wait to see the new policy direction (if any) after the election.
It’s hard to believe, but Peloton has been a public company for a mere 13 months. Over that time, its stock crushed the market, returning nearly 400%, and for good reason. Revenue is growing at a triple-digit pace, and its products allow users to exercise at home, which is important in this coronavirus-impacted year. But this is far more than a hardware company. Each equipment sale starts a (pricey) monthly subscription to Peloton’s high-margin video content.
Some investors note that gyms have been operating at limited capacity in 2020. What happens to Peloton’s pandemic cohort of users once lower-priced gyms reopen? This concern may be overblown. The company’s customer retention metrics were…
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