For months, I’ve been telling you about the market-beating returns you can earn from tech IPOs…
And I’ve been encouraging you to make them a part of your overall investment strategy.
But in case you need a reminder, this data from Renaissance Capital says it all:
- On their first day of trading, 80% of tech IPOs rise by an average of 36%.
- And those gains keep coming: the average tech IPO is up 82% from its first day of trading.
I challenge you to find a better opportunity to earn lightning-fast gains anywhere in the market.
But I’m not bringing up past performance to make you feel bad about what you missed out on.
Instead, I want to make sure you understand the profit potential for the market’s next “hot” tech IPO…
The Next Hot Tech IPO
Last week, I shared that Silicon Valley-based Sumo Logic (Proposed Ticker: SUMO) filed to go public.
You’ll recall, the company operates in the red-hot software-as-a-service (SaaS) segment, which is dominated by companies like the $245 billion market cap Salesforce.com (CRM),
The reason so many investors covet SaaS companies couldn’t be more straightforward — they offer high-growth, high-margin recurring revenues, which often translates into (much) higher stock prices.
Case in point: On the heels of reporting a solid 30% increase in quarterly sales, shares of Salesforce.com surged nearly 30%.
Even more impressive, the stock is up nearly 70% year-to-date, more than doubling the return of the Nasdaq index over the same period.
I’m convinced Sumo Logic could be the next SaaS company to deliver the same type of market-beating returns.
But before we decide to invest in the company, let’s confirm it meets the “Five Hallmarks of a Worthy IPO” that I told you about…
Putting Sumo Through Our IPO Filters
This 5-step IPO screen is a proven strategy I’ve used for years to identify the market’s next hot IPOs.
Here’s how Sumo stacks up…
- Offering size: Remember, we want to focus on offerings of $100 million or more, as this threshold weeds out the riskiest deals, and ensures there will be ample liquidity in the aftermarket. Sumo’s initial plans call for a $100 million offering, so it looks like it just passes this thresholder. However, I fully expect the company to increase the size of the offering before it officially goes public. So it clearly meets this criterion.
- Revenue: Research from University of Florida revealed that revenues are a strong predictor of stock performance. The key threshold is $50 million for the 12 months prior to an IPO. Companies below that level underperformed the market by ~15% for the next three years. And those above this threshold outperformed the market. Sumo passes with flying colors, as revenue in the last 12 months topped $155 million.
- Long-term growth potential: An IPO is an investment in the future growth potential of a company, not its past growth. With that in mind, we insist that every company has at least a $1 billion addressable market at the time of its IPO. And it’s easy to determine this — the addressable market is typically listed in the IPO prospectus under the heading, “Market, Industry and Other Data.” Sure enough, Sumo’s filing reveals “its total addressable market opportunity to be approximately $55.1 billion.” That’s 55 times more than our minimum.
- Insider ownership: Insider ownership is a good way to gauge if management’s interests are aligned with our interests. This figure is listed in the prospectus under the heading, “Principal and Selling Stakeholders.” If insiders retain at least 10% of the company post-IPO, the incentive exists to do exactly what we desire: increase share price. In Sumo’s case, insiders own 11% of the company.
- Profitability: Unless a company is profitable (or on a clear path to profitability), we avoid it. After all, share price ultimately follows earnings. So if a company does nothing but lose money, investors can expect the same. However, when it comes to SaaS companies, we have to make some adjustments. You see, it’s typical for such companies to keep reinvesting in growth and therefore lose money for years. As long as revenue growth tops 25%, we can tolerate losses. In this case, Sumo is growing its revenues at a 50% clip, so we can overlook the lack of profits.
It All Comes Down to Valuation
To be clear, I’m not recommending buying Sumo’s IPO blindly.
Why? Simple: The price hasn’t been determined yet, so we don’t know how cheap or expensive it will be.
Pricing is the last step in the IPO process, and it typically happens the week before the IPO.
However, we can establish a fair price range based on the valuations of other publicly traded SaaS companies.
If we use Salesforce.com and its price-to-sales ratio of 13 as a benchmark, we should be willing to pay up to $25 for shares of Sumo, based on the company’s latest sales figures.
We’ll find out soon enough if we’re going to get that opportunity. For now, put the company on your “Hot IPO” watch list — and stay tuned for updates.
Ahead of the tape,