Why Trading IPOs Is a Tough Gig for Contrarians

It's wise to be wary of new stocks on Wall Street, even when sentiment seems extreme

by Bernie Schaeffer

Published on May 14, 2019 at 10:54 AM

"Each month, TD Ameritrade Holding Corp. (NASDAQ: AMTD) reveals which stocks were among the most bought and sold by their clients via the Investor Movement Index, which tracks investor behavior by measuring holding and trading data from a sample of clients... Unsurprisingly, retail investors flocked to some of the most headline-driven names in April. LYFT Inc (NASDAQ: LYFT) was a net buy after IPOing at the end of March and subsequently trading below its IPO price."
-- Benzinga, May 9, 2019

"Lyft's IPO led us to be a bit more conservative."
-- Uber CEO Dara Khosrowshahi on CNBC, May 10, 2019

To observe that LYFT Inc (NASDAQ:LYFT) traded below its initial public offering price (IPO) during April somewhat undersells the degree to which the ride-hailing company utterly flopped in its first full month of trading. After pricing its late-March IPO at $72 per share -- well above the $62-$68 range that had been in play just two days prior -- LYFT started its tenure as a publicly traded company with a value of roughly $24 billion.

As Schaeffer's Quantitative Analyst Chris Prybal pointed out in an internal email thread at the time, LYFT's lofty IPO price valued the ridesharing name above Kroger (KR), the nationwide grocery monolith. But the stock immediately retreated from its opening-day heights around $88, and it was as soon as April 1 that the New York Times website ran the headline, "Lyft's Stock Drops Below I.P.O. Price in Second Day of Trading."

With LYFT cratering so hard right out of the gate -- and so publicly, to boot (followers of our contrarian analysis will clock the significance of the NYT, hardly a niche financial publication, featuring the second-day performance of the Lyft IPO as a story of note to its readership) -- we have to consider that the retail traders who were net buyers of LYFT in April may have actually considered pessimism on the app-based taxi service to already be at some kind of likely climax.

In other words, given the steep discount to their IPO price at which LYFT shares were trading through much of April, the shares may have seemed like a "steal" to bargain-hunting investors -- particularly with LYFT repeatedly finding support for its daily closing lows around $56 during the second half of the month. That emerging technical floor was located just below the $57.20 level that marks a 20% correction from the $72 IPO price, and prior to last week, LYFT had closed only four sessions total below this "micro bear market" threshold.

But last week was particularly punishing for LYFT, and things took a turn for the worse on the charts. In the company's inaugural public earnings report, Lyft revealed a massive quarterly loss of $1.1 billion, while Chief Financial Officer Brian Roberts said, "We anticipate that 2019 will be our peak loss year." This gloomy announcement occurred against the backdrop of a strike by the "gig" employees who make up the ride-sharing company's workforce, and preceded the Friday IPO of rival Uber (UBER) -- which thrust the unfortunate circumstances of Lyft's own IPO back out in the public square for re-inspection.

Analysts at J.P. Morgan Securities, Cowen, Jefferies, and Stifel all responded to LYFT's lemon of an earnings report by handing out price-target hikes, while the stock went on to close each of the next three sessions (including Friday's weekly finish) below that once-solid support at $56, and well south of the 20% correction level from its IPO price. In fact, in Thursday and Friday's trading, $56 was beginning to look like an overhead ceiling for LYFT, per the accompanying chart.

And if Uber played it "conservative" by pricing Friday's IPO toward the low end of the projected range, at $45 per share, it still wasn't quite conservative enough for Wall Street, which seems to have collectively lost its appetite for the ridesharing trade. At its intraday low of $41.06 on Friday, Uber stock was down 8.7%, and never made it into positive territory. (The accompanying NY Times headline: "Uber's Stock Disappoints, Capping a Rocky Path to Its I.P.O.")

The takeaway here is certainly not that last month's retail buyers of LYFT were "dumb money," by any means. Instead, it's that a useful, tradable sentiment backdrop takes time to develop. Trying to "fade" the consensus sentiment on a new-to-Wall Street stock is a strategy that's notoriously easy to fumble, because there's so little history to draw from -- in terms of both price action and what counts as a "normal" degree of euphoria or despair for a given stock.

So while LYFT may have reasonably looked appealing to "bargain shoppers" after the heavy post-IPO sell-off, coupled with April's combination of successful tests at technical support and broadly negative media coverage, it seems safe to observe after last week's action that we don't yet know with certainty what a bearish climax looks like for Lyft.

lyft stock chart since march 2019

Subscribers to Bernie Schaeffer's Chart of the Week received this commentary on Sunday, May 12.

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