IPOs: Lots of Hype, Lots of Risk
IPOs get a lot of attention in the news, but they are among the riskiest investments you can make.
Last month I wrote about how I'm generally pretty skeptical about the "next big thing" in investing. By the time the word gets out to the masses, the opportunity to get in on the ground floor is usually gone. All that's left is an echo chamber full of hype and some really high prices. Talking about hype and high prices reminds me of another area of investing where I generally encourage DIY investors to tread carefully: IPOs.
An IPO is an Initial Public Offering. It is when a private company offers shares of its stock on a public stock exchange for the first time. In the past, IPOs were a way for companies to generate capital, which they could use to grow their businesses. Lately, it has also been a way for founders, early investors, and venture capitalists to cash out of their investments.This year there has been a frenzy of IPOs. Some of the many companies that have IPO'd this year include the pet food delivery company Chewy, the ridesharing company Uber, and the social media image board site Pinterest. Some of the bigger technology IPOs this year include Zoom, which offers online video conferencing, and CrowdStrike, a cybersecurity company that uses artificial intelligence.IPOs garner lots of media attention, especially when the companies have huge name recognition like Uber.But here's the problem:It's hard for the average investor to buy an IPO at the price it is initially offered.The offering shares are usually reserved for institutions and ultra-high-net-worth brokerage clients. This can create pent up demand when shares first start to actively trade on an exchange. As a result, it's not unusual to see an IPO trade up double-digits in a stock's first day of trading. And when regular people see the price pop like that, it creates even more demand -- and so on and so on. And often, it is the individual retail investor who ends up paying a premium price.Let's take a look at the price charts for some of these companies.Uber
Two weeks after its IPO, Uber (shown above) was viewed as a dud, although it has since climbed back up above its IPO price.Pinterest's stock (below) popped 28% on its first day of trading on April 18. Investors continued to chase up its price to $34.26 by April 29. In early June, it had dropped back to $24.06 -- or 30% off its highs. Less than three months since its IPO, it's probably still too early to say Pinterest has found its post-IPO trading range.Pinterest
In some cases, a stock's price might settle well below where it traded in the heyday of its IPO.For instance, the company Groupon (below) had an IPO price of $20 per share when it went public in 2011. On its first day of trading, its price popped 31%. Less than 13 months later, shares were trading at roughly $5 per share, and the price has never really recovered.Groupon
One recently IPO'd stock that everyone is talking about is Beyond Meat (below).Beyond Meat
The company produces plant-based meat alternatives, and its stock has risen 147% since it went public in early May.Over time, a new stock becomes an established stock and its price may stabilize. In some cases, that price is substantially higher, making everyone who risked buying it during its volatile debut look like a genius.But it's very difficult to predict which new stocks will turn out winners, and you definitely can't make that prediction on name recognition alone. Everyone in the country had heard of Uber before it went public, and its stock is doing just OK. Practically no one except vegans and professional investors had heard of Beyond Meat before it IPO'd, and its stock is doing great.Takeaway: If you’re not going to be one of the anointed few to get in on the ground floor, then you might want to wait until the volatility subsides to buy a new stock.If you buy a new stock on its first day of public trading, you need to view this as among the riskiest investments that you can make.