Why equity investors should be wary of unicorns
By: Tim Bennett
25.04.2019
Some of the latest high-flying tech stocks coming to market are likely to disappoint investors. Tim Bennett Explains why in his latest video.

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Background

For anyone who has managed to miss the hype around them, unicorns are private companies with valuations of over $1bn. Having been incubated by private equity and venture capital firms over the last few years, a whole batch of them are being sold to investors via initial public offerings (IPOs). The question is, should you dive in or duck?

Examples

Many of these new stocks are not new at all, in that many people have heard of them and already use their services. Although they all do slightly different things, they are connected by the fact that they connect consumers to a useful service.
Some of these firms have been game-changers. AirBnb, for example, has revolutionised the way people book accommodation. However, this doesn’t necessarily make them good investments.

A brief summary

Another thing these unicorns share is a common history of being grown away from public markets using private capital.

So, what’s the problem?

Although many investors will want a slice of these new disruptors, I think there are several reasons to steer clear – by all means use and enjoy the apps but don’t expect to make a fortune on the shares. Here is why.

They are popular

Buying companies that you know and are familiar with can be a great idea. However, in this case it may be the reverse. Warren Buffett once said, “be fearful when others are greedy” and this would seem to be a good time to heed his words. These firms, after all, are not undiscovered bargains – they are hyped giants. As such, I would be wary.

Most lose (lots of) money

I am a bit of a traditionalist when it comes to investing, in that I like to buy firms that are making money. The problem with the unicorns is that very few of them do and it’s not clear how they will in the future. Most have expanded fast with no clear route to earnings growth and positive cash flow. Again, not my cup of tea.

They are priced to go

Investors hoping to bag the next Amazon need to be careful. That’s because these stocks are not cheap. At the time of writing Lyft and Pinterest were valued on about 10 times sales, which hardly makes them cheap.

Insiders are selling

Private equity and venture capital firms have spent years building these firms and yet now they are selling into public markets. Although an argument can be made that this reflects a need to allow these unicorns to further scale up, my suspicion is that these insiders sense that most of the value of these newcomers is baked into their IPO valuations. It’s another reason to avoid them.

IPOs can be tricky for novices

When firms first come to public markets via an IPO you will often see a “kick” in the share price. Investors who can get in at this stage often do well subsequently. However, those who don’t fare less well as research from Jay Ritter at the University of Florida reveals below;
In short then, although Unicorns stocks are exciting, for all of these reasons I am inclined to stick to more boring offerings as an investor.