The blockbuster first week of the Arm Holdings Plc IPO marked the grand reopening of the new issue market following a yearlong drought, and here’s how Goldman Sachs says to navigate the new landscape. Goldman was one of four lead advisors on the Arm initial public offering. First and foremost, the Wall Street investment bank advised clients to focus on identifying companies capable of growing sales at a fast pace and achieving profitability in their first years as a public company. Goldman analyzed nearly 5,000 IPOs completed during the past 25 years, and found that deals that outperform share two characteristics: Greater than 40% annualized sales growth in their second and third years after the IPO; positive net income by their eighth quarterly earnings report. Companies with these characteristics have been rewarded with significant outperformance. Two thirds of IPOs with these two traits outperformed the Russell 3000 in their first three years, with the typical company beating the benchmark by 22 percentage points. “We expect profitability will be especially important for upcoming IPOs,” David Kostin, Goldman’s head of U.S. equity strategy, said in a research report. “With capital markets closed for nearly two years, unprofitable companies have been forced to fund operations by spending cash balances.” The IPO market dwindled over the past year as an aggressive Federal Reserve and recession fears quashed the appetite for new issues. As interest rates stabilize, albeit at higher levels, and the stock market hangs on to 2023 gains, a wave of deals are about to test the market again, including grocery delivery firm Instacart, shoe maker Birkenstock, marketing automation company Klaviyo and carsharing provider Turo. Wary of high valuations Goldman warned investors about IPOs that have high valuations. The bank found that deals with price-to-sales multiples greater than 15 times during 2020 and 2021 later performed poorly. None of those high fliers outperformed the Russell 3000 over their first two years, and an average company in the group lagged the benchmark by a whopping 84 percentage points. “Investors should also be wary of IPOs that come to market at extremely high valuations,” Kostin said. “Many of the most highly valued IPOs were brought to market by venture capital firms.” Day 1 indicator IPOs that pop dramatically on the day that they debut can typically sustain their rally in the short run, Goldman said. Deals soaring by more than 50% on their first day of trading typically appreciate by an additional 5% during the following three months, according to Goldman’s data. Arm Holdings , the chip design company controlled by SoftBank , jumped nearly 25% on its first day of trading last week. Conversely, IPOs that fall on their first day typically decline by an additional 4% over the subsequent three months. But Goldman noted that the first day indicator doesn’t correctly predict IPOs’ long-term performance.
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