There will be only one IPO in June, just as in April and May. We have never seen this happen since the inception of Japan’s three small company stock markets. During the first five months of 2008, there have been 23 IPOs. Seven companies listed on JASDAQ, seven on TSE Mothers, three on the TSE 2nd section, three on OSE Hercules, and one each on JASDAQ NEO, Nagoya Centrex and Sapporo Ambitious. For these 23 companies, the opening price was an average of 33.5% above the offering prices.

Since 2000, the only year with a smaller premium was 2000 with an average of 18.5%. But the closing prices of the 23 companies on May 30 were an average of 76.1% above the offering prices and 42.6% above the opening prices.

Eight of the 2008 IPOs had a May 30 closing price below their offering prices. But the May 30 prices of seven of these issues were more than twice their offering prices. Netyear Group and SMS, which both listed on TSE Mothers, are now valued at more than three times their offering prices. These strong performers explain why the average premium over offering prices is so high.

Why are IPO stocks performing so well on the secondary market? The number of IPOs has dropped to almost nothing in recent months as prices on small company stock markets slumped. This situation produced a big improvement in supply-demand dynamics due to the smaller amount of capital procured through IPOs.

Furthermore, most investors who hold small company stocks other than the recent IPOs have no flexibility because market prices now are below their cost. This is probably another reason that recent IPO stocks, which have prices that can move with relative ease, are attracting so much interest.

Investors should expect the current situation, where prices of IPO stocks climb after the listing, to continue as long as there are no prospects for a major shift in the supply-demand balance.

With market prices now 76.1% above their offering prices, investors may jump to the conclusion that these stocks are now overvalued. But I think it’s too soon to adopt this position.

As I have noted many times in the past, valuations of peer companies used to determine offering prices are now very low. That means recent IPOs have been given offering prices below their fair value.

To determine an offering price, a securities company begins by calculating a fair value based on peer company valuations. An IPO discount is then applied to obtain the offering price. Most market observers agree that this discount has been about 30% since the summer of 2007. The average opening price premium of 33% for the 2008 IPOs therefore brings these stocks back to about their fair values.

There is an interesting pattern for the average forward PER for JASDAQ, the small company market with the most IPOs. Over the past decade, the average forward PER has dropped below 20 only three times: 1997-98, 2002-03 and 2007-08. As you can see, the multiple falls below 20 once every five years.

After the average JASDAQ PER went below 20 in 2002-03, this multiple shot up to almost 50 in 2005. Undoubtedly, very few market observers in the spring of 2003 expected the JASDAQ’s average PER to reach 50. This time as well, I think it is quite possible that history will repeat itself.

Therefore, past trends in IPO stocks show that current IPO valuations are still far below a level that could once again produce an IPO bubble.

When the number of IPOs becomes this small, we can surmise that only companies able to meet the strict standards of lead underwriters and stock exchanges have been allowed to go public. In recent years, the hurdle for IPOs was lower. But now, we are about to return to the time when the ability to conduct an IPO was proof of a company’s integrity and soundness. There might have been a bubble when the average JASDAQ PER approached 50 in 2005. But today’s valuations are nowhere near a bubble. This is why I am probably not alone in wondering why we are not seeing some sort of premium valuation for IPO stocks right now.