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.

Annual numbers of IPOs from 2010 to 2018, classified by sectors

Monthly numbers of ICOs from 2016/01 to 2019/01

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: