Commonly referred to as the Netflix (NASDAQ:NFLX) of China, iQiyi (NASDAQ:IQ) went public Mar. 30. Since then, IQ stock has gone on a roller-coaster ride with a 52-week high-low spread of $30.93, which is a lot for a stock whose IPO price was just $18.
You would think with all the trade-war talk that investors would be scared of buying into Chinese stocks listed on U.S. exchanges, but that doesn’t appear to be the case with iQiyi.
In two days at the end of June, IQ stock lost 26% of its value only to regain most of those losses over the next two weeks.
There are a lot of investors who don’t want to miss out on the second coming of Netflix and are willing to buy IQ stock at any price to get in on the action.
Here’s Why That’s a Bad Idea
CNBC’s Jim Cramer recently gave a traditional explanation why you might want to think twice about buying iQiyi.
“In the midst of the trade tensions with the People’s Republic, China-based companies keep coming public here, and their stocks have been roaring,” Cramer said Jul. 5 on Mad Money. “Many of these names, though, [are of] dubious quality.”
IQiyi had an operating loss of $169.4 million in the first quarter on $777.6 million in revenue. While revenues increased 57% year-over-year, its operating loss was only marginally higher from last year, which is either positive or negative depending on your viewpoint.
If you subscribe to the idea that a company has to scale its business before making money, then the fact it didn’t have a higher loss in Q1 2018 is a sign that it will get to money-making status sooner rather than later.
However, if you believe that 57% growth in revenue should deliver a corresponding decrease in operating losses, then iQiyi is failing miserably.
The IPO Market Is Ready for a Correction
Regardless of whether you believe Chinese companies are the real deal or all smoke and mirrors, it is the state of the IPO market that should have you skeptical of IQ stock moving higher.
“Here’s the bottom line: even with the recent downturn in newly minted IPOs, the market for IPOs is red-hot and these big deals [will] keep coming,” Cramer said. “The next time some fresh-faced IPO catches fire, think about all of the recent turmoil and remember to take profits rather than letting your gains ride, at least on a portion of your position.”
How hot is the IPO market?
Well, according to The Wall Street Journal, the average IPO in 2018 is up 22% from its IPO price. Tech IPOs are even hotter, up 53% on average since going public in 2018.
Meanwhile, the number of companies going public without any earnings like iQiyi hit 76% in 2017, the highest percentage since 1999 and 2000, and we all know what happened shortly after that.
So, combine the fact IPO stocks are hotter than they’ve been in years with the lack of earnings backing these stocks, and you’ve got the makings of a market top.
I believe the U.S. is headed for a recession sooner rather than later because of Trump’s unnecessary trade war with China. This is a situation that is bound to hurt U.S. stocks in ways investors can’t possibly anticipate.
Why IQ Stock Could Fall by More Than 50%
Billionaire Canadian investor Stephen Jarislowsky, now in his 90s, wrote a book in 2005 called The Investment Zoo. In it, he says you shouldn’t buy IPOs.
“New issues are typically well promoted,” wrote Jarislowsky in his 2005 book, The Investment Zoo. “My experience is that you can buy nine out of 10 new issues at a lower price a year or two later … I generally avoid new issues….”
As I write this, IQ stock is trading around $36, double its March IPO price. Jarislowsky believes you’ll be able to buy it for less than $18 in the next 20 months or so.
With the markets looking as though they could be in for a significant correction over the same period, I’d be cautious about the bets you make, including iQiyi.