The SpaceX IPO Trap for Retail Investors

In this episode of Through the Noise, Cam Harvey unpacks his newly published Financial Analysts Journal paper, "Fundamental Growth," and applies its lessons to the most anticipated IPO of the year: SpaceX. Cam explains why traditional value and growth indices misclassify stocks, leaving investors exposed to expensive, low-growth names. He then turns to the mechanics of the SpaceX offering, a $1.75 trillion market cap with only 4 percent float, and reveals how accelerated inclusion rules at Nasdaq, S&P, and Russell will force passive funds to chase a tiny pool of shares. The result is a predictable price surge that benefits insiders while leaving retail investors holding the bag. A timely, analytic-driven look at the structural forces shaping modern markets.

Transcript

SPEAKER_00 0:00

Welcome back, everyone, to another episode of Cam Harvey's Through the Noise. Cam, my understanding is that you have a new paper that just got published that we can read about growth stocks, about investing in general. And this period of time, we're seeing a lot of movement in the IPO space. We're hearing news about Anthropic, about OpenAI, about SpaceX. And I think it might make sense for us to kind of dig into that. And why don't we look at SpaceX? It's the biggest uh and probably the most tangible of these uh of these IPOs that are coming up.

SPEAKER_01 0:38

Sure. So my paper, uh which was just published in the Financial Analyst Journal, is called Fundamental Growth. So it does fit well with what's happening in the market today because SpaceX is classified as a growth stock. So we usually divide the investment universe into two types of stocks. Um one is a value stock, where the value is cheap, and when I say value, it might be the price-earnings ratio, and then growth stocks, and these are often expensive, so a high price-to-earnings ratio, but they offer um a very high growth rate. And we know we value stocks by looking at the future cash flows, discounting them back to the present, and that high growth rate already has a multiplying effect on the value. The other factor is that investors often have a preference for a stock that might have an extreme upside. So think of this as a lottery-like uh payoff, where there's a small probability of an explosive upside. And investors are willing to pay for that. And this is a bit paradoxical, uh, even though given the very high price or price earnings ratios, the expected return might be low. But they're willing to trade that off for a lottery-like payoff. And again, the lottery is a right analogy because the lottery, the expected payoff on a lottery is negative. But you're buying it for that really big uh upside.

SPEAKER_00 2:36

So getting back to specifically SpaceX, is this a lottery ticket? If when it comes out as a retail investor, should I be looking to get into it?

SPEAKER_01 2:48

Okay, so before you go to SpaceX, if you don't mind, can I kind of pitch uh the idea of this uh new paper, Fundamental Growth? And and then uh we can go into SpaceX. So the idea of my research is to look at value and growth differently. And this is an insight that uh is recent to me uh but is well known by many. And that is that if you look, for example, at the Russell 1000 value index and then the Russell 1000 growth index, and put an equally weighted portfolio of those two indices together, that exactly equals the Russell 1000 index, the overall index. So the implication of that is that if the stock isn't in the value index, it's in the growth index, and vice versa. And that creates an immediate problem. And that is that if you were doing this 50-50 value and growth, you are investing in expensive low-growth stocks. Okay, and think about that. So if a stock is expensive, a high PE, I'm willing to buy that if there's a very high growth potential. But if it's expensive and the growth is low, there's just no good reason to put that in your portfolio. It's really hard to make the investment case. How do we know the difference? Yeah, so uh again, it's it's fairly straightforward. Uh, you need some growth metrics, and this is what we do. So we've got obvious fundamental metrics for growth. Think of sales growth, RD growth, profitability growth. Those are growth measures. Uh and then value measures, think of again, price to earnings ratio or price to book. So there are certain securities that are expensive and uh and low growth that you should exclude. So what we do uh in constructing a new kind of approach to growth investing, there's two steps. Number one, what we do is we look at the fundamentals. So again, the profitability growth, the RD growth, the sales growth. And those are the metrics that we select the stocks on. We we don't select a stock just because it's expensive and assume it's a gross stock. No. So the second thing that we do is the way that we weight the stocks. So often stocks are weighted by market capitalization. No, we're not going to look at market capitalization. We are going to wait by the growth fundamentals. So think of the same sort of metrics that fundamentally represent growth. We're going to use those instead of market cap waiting. You put that together, and it's uh very promising. Uh and I think that it is a gap that should have been filled a long time ago uh to actually view growth from a fundamental perspective.

SPEAKER_00 6:25

So that said, um, you asked specifically about the just so I understand, you're you're specifically saying there's a mechanical way for us to underweight high-priced, low-growth stocks that are not, that's not presently how the Russell 1000 or these indexes are.

SPEAKER_01 6:42

That's correct, uh, because they are uh market cap weighted. Okay. So market cap weighting is kind of standard uh in the industry. The key problem with that weighting is that it mechanically overweights overvalued stocks and underweights undervalued stocks. So that's why it's very important to go to fundamentals.

SPEAKER_00 7:12

So then maybe coming back to SpaceX, how do we think about that?

SPEAKER_01 7:17

Contingent on that. Sure. Let's let's talk about SpaceX. So it's in the news, and there's certain things that maybe are not played up in the news as much as they should be. So we know that the total market capitalization will be $1.75 trillion. We also know that what is being offered to the public is $75 billion. So that's roughly 4% of the market capitalization. So the amount of float that will be available out there is going to be small. So what are the implications of that? And there are many. So number one, these index tracking um ETFs and and mutual funds, they track based upon the total capitalization, the 1.75. So they're going to be buyers. And the SpaceX IPO will be offered on NASDAQ, and for a good reason. NASDAQ changed the rules for the inclusion in the NASDAQ 100 uh index. So it used to be you need to wait three to 12 months. No, they sped that up to uh 15 days. Um, they changed the rules for the top 40 uh companies, and uh SpaceX should enter within the top 10. And importantly, and this is very important, they changed the rules on the minimum amount of float. And that used to be 10%. So they will make an exception for SpaceX. So think of within 15 days, all of the funds that are tracked to the Nasdaq 100 will be buyers. SP is thinking of changing the rules also, and they will likely change the rules. This is a giant IPO, and they want to have um to have SpaceX and the SP 500. And the usual approach SP has is to wait 12 months and uh for the company to show four profitable quarters. Well, that doesn't work for SpaceX. Actually, SpaceX has got uh a $4.28 billion loss uh over the last uh 12 months. And and certainly uh 12 months is a long time to wait. So SP will actually speed up its process. Russell is also including speeding up their process. What does this mean? So if you look at the amount that these passive indices need to buy, it's roughly 25% of that float, the $75 billion. And then I estimate another 25% uh needs to be bought by active funds that are benchmarked to these indices. So they're they're kind of closet passive investors, and they will need to buy. So think of 50% of that float is is going to be purchased by passive funds. And it's likely that the retail investors are going to be losers on this. Everybody knows the price is gonna go up. The retail investors were excluded from the non-public equity that has been available for sale for quite a while. And by the time they get in, and you know how this works, that if the stock is going into the NASDAQ 100 in 15 days, the price goes up uh today. Uh so I think that many retail investors are going to be caught uh by this um this surge in the price. They will not participate, even though some of the IPO is allocated to Robinhood and Schwab and other uh retail platforms, uh, the price will likely go up uh very quickly, and many retail investors will be losers.

SPEAKER_00 11:51

This sounds, I mean, I've heard about this one. I've ever sort of seen the math put together. And it seems like now passive investing has grown so much that these IPO candidates can even think about that in their strategies. And it sounds like a really bad place for passive investing to be. It sounds like the passive investor is gonna get kind of like clobbered by by the mechanics of this.

SPEAKER_01 12:16

So this is also important. The passive investor or the investment vehicle doesn't care about the fundamentals, and this kind of loops back uh to my paper. So they only care about the price. And if that price goes up, it just means that the weight uh goes up. New flows come in and they're directed based upon the price. The fundamentals are completely irrelevant for the passive investor. So again, we've got a number of problems here. So to me, uh you're pointing to the issue of passive investing, and that is a problem. But in this particular case with SpaceX, there's just not enough float. And when you're offering only 4%, uh and given the passive investment um complex, that will distort. And again, let me emphasize that the 4% is not what the passive index funds are looking at. They're looking at the 100%, they're looking at the $1.75 trillion. They need to target that proportion to the market, not the $75 billion. So this potentially could cause some distortions uh in the price. Of course, uh, for the insiders of SpaceX, this is a great uh benefit. And I think that uh these changes in inclusion in terms of the fast track, uh, I think are also uh causing issues. Again, uh the bottom line here is given the float is so small that I'm I'm worried that the retail investor will be a loser. And this is perhaps part of a larger conversation because the retail investor has been excluded from all of these non-public uh properties. And there's many that are in the news. So it's not just SpaceX. Think of OpenAI, think of anthropic. These are giant firms, and the average investor can't access the equity. If you're rich, you get to buy it, and you get to buy it early, and you get to reap the return. The retail investor is relegated to the IPO, and given this particular situation, they're set up to be a loser.

SPEAKER_00 15:06

Well, Cam, I think this sets up a thread of different conversations about what it means to be a retail investor, what we need to be thinking about in our in our positions. And I think we can find some time to talk about that in the future, I hope.

SPEAKER_01 15:19

I certainly hope so too.