What's Going on With the Boom in Profitless Stocks?

For investors looking to place bets on newly public companies, 2014 has been an amazing year. Through the month of August, 204 businesses have held initial pubic offerings for their stock, for a combined value of $46.4 billion. According to the Wall Street Journal, both of those numbers are the highest the IPO world has seen since 2000.

But 2014 is close to setting another millenium record: The percentage of IPOs where the company has negative earnings--that is, is losing money--is nearing a 14-year peak. A report from Asset Allocation Advisers, using data from SentimenTrader, shows the proportion of in-the-red IPOs recently hit 83%, just one point lower than their previous high in 2000. That year seems to be coming up a lot--remind me what happened around then?

Oh, right.

The last time such a large share of IPOs were profitless was at the top of the dotcom bubble, and when that bubble burst, the S&P 500 lost almost half of its value. Gregory Schultz, co-owner of Asset Allocation Advisers, and co-author of the report, thinks more earnings-free IPOs are one indication the tech bubble is back.

"It might come in the same box with a different color bow, but like Yogi Berra said, it's deja vu all over again," Schultz told Money. "The impression I get is if you have a mobile app and a website, you can gather money."

Why is the market so willing to support the latest web startup, never mind profits? Schultz thinks low interest rates and the Fed's policy of "quantitative easing" have made investors are more willing to put their cash in risky ventures in hopes of capturing a higher return.

But while some think the new IPO boom could mean the market is overvalued, others see a different explanation. Rich Peterson, an analyst at S&P Capital IQ, says a surge in profitless IPOs is actually driven by the kind of companies seeking public investment. And it's not just tech stocks. "One of the more popular or active sectors for IPOs has come in the biotech field," says Peterson. His numbers shows this type of firms taking up about 22% of year's IPO market so far. "By their nature, biotechnology companies don't make money [early on], they burn through a lot of cash, so it's not surprising."

Early indicators suggest most of 2014's IPO class is actually doing quite well. Of the 134 companies that did IPOs this year and reported second quarter earnings, 72 beat analyst expectations, and only 54 missed their mark. Peterson cautions that an IPO's early success does not guarantee good results in the long run, but says the high share of zero-profit IPOs does not concern him.

Of course, the simplest explanation for more earnings-negative IPOs is that stocks are currently in high demand. The S&P 500's price-to-earnings ratio, based on ten years of average earnings, is a little above 25. That's higher than historical norms, meaning the public is willing to pay a lot for equities in general. When investors are especially eager to buy stock, it makes sense for companies to obtain capital (or for founders to cash out) by selling shares. In short, the rise of the no-profit IPOs is a predictable side effect of the market boom. Less predictable is when the boom ends.