A major shift in U.S. markets happened in the last decade or so. And most people still haven’t realized how significant it was.
Here’s the problem: High-growth companies are staying private longer than ever.
Doesn’t sound like that big of a deal, right?
Let me explain why I think it is.
Look at the fastest-growing companies in the world today: Uber, Airbnb, Spotify, Palantir and Dropbox. All are private, with valuations well into the billions (Uber’s most recent round of funding valued the company at $41 billion).
When these companies go public, private investors will probably have made the majority of gains to be had.
How did we get here?
Some say it was a consequence of the Sarbanes-Oxley Act of 2002. That legislation increased the cost of being public, for some companies, by roughly three times.
Others say larger and later IPOs are a sign of stress in the economy. The theory being that public markets are comfortable with only large, mature companies during hard economic times.
Or maybe it’s partly due to all that liquidity (cash) sloshing around in private markets thanks to the Fed’s low-interest-rate policies…
Whatever caused it, the trend is real. And it seems to be getting stronger.
Take a look at this chart. The orange line is average IPO offering size. The grey bars show the number of IPOs per year.
Since 2000, companies are going private later at larger valuations.
One of the consequences affects us all: Public market investors are missing out on some of the hottest growth stories of our time.
Companies in their prime growth years, all but unavailable to most investors…
Consider these two IPOs, 18 years apart.
Microsoft IPO: 1986
- Valuation on opening day: $500 million
Post-IPO investor return over first 10 years: 7,500%
Valuation today (market cap): $339 billion
Google IPO: 2004
- Valuation on opening day: $24 billion
Post-IPO investor return over first 10 years: 956%
Valuation today: $374 billion
Today, Microsoft and Google are both worth over $300 billion. Yet early investors in Microsoft stock cleaned up, gaining 7,500% over the first 10 years of public trading.
Over the first 10 years after Google went public, IPO investors made 956%. Not bad, but almost an order of magnitude less than early Microsoft investors made in that time frame.
Since Microsoft went public in 1986, the stock is up 40,000% from its IPO price. And that doesn’t even include dividends…
Microsoft went public at a time when it was normal for hot tech companies to go public relatively early.
By the time Google went public, it was already a $24 billion company! The upside at that stage can never match a nice $500 million firm like Microsoft was when it went public.
Big Mutual Funds Take Notice
Take a look at this chart from CB Insights. It shows how big mutual funds are getting active in late-stage private-tech investments.
These are big firms. T. Rowe Price, Fidelity, Wellington, Black Rock. They’re all suffering from FOMO – fear of missing out (on growth). And rightly so, in my opinion.
A big money manager simply has to go private these days to gain access to the growth its clients want.
What’s a Stock Investor to Do?
Mutual funds that participate in private deals aren’t a great option. Usually these investments make up a tiny percentage of their overall portfolios.
The problem we’re tackling here is best addressed by accessing private markets directly. It’s a big part of why I created Early Investing.
Private markets are undergoing revolutionary changes thanks to legislation like the JOBS Act of 2012.
For the first time ever, accredited investors can put small amounts into fast-growing private companies. And do it all online. It’s still a small market, for now. I’d guess the overall market did around $600 million online last year. But it’s growing fast, at around 500% a year (again, this is only an estimate).
Our premium service Startup Investor is already helping accredited investors access private markets. We’ve issued 21 early-investment recommendations so far.
We also arranged a special “late-stage, pre-IPO” series of funds for members. More than 230 members have invested so far. (Membership is currently closed, but we’ll be opening up new spaces soon.)
And once the JOBS Act is fully implemented, every adult in America will be able to participate in this exciting market.
So stay tuned. We’ll be covering every aspect of this rapidly evolving space.
Silver Lining in Small Caps
Many of today’s fastest-growing tech companies are essentially bypassing the small cap phase altogether (meaning stocks with a market cap of between $200 million and $2 billion) by staying private longer.
You can probably guess what has happened as a result. Big Wall Street firms have basically stopped covering publicly traded small cap stocks. Too much of a bother for these “too big to fail” behemoths.
So although there are fewer small companies going public today, there are also far fewer analysts covering them. Having fewer “sell-side” stock analysts covering small caps means fewer buyers. And, sometimes, better prices.
In next week’s letter, I’ll be covering some of my favorite under-the-radar small caps. They may not be the hottest names in tech, but this overall lack of analyst coverage has created some attractive values.
Founder, Early Investing