2019 is shaping up to be quite a year for initial public offerings (IPOs).
Lyft, Uber, Levi Strauss… These companies and their high valuations are drawing attention, and you’re probably wondering whether you should jump on board. After all, an IPO is a rare, one-time chance to buy a stock at the very beginning.
However, IPOs are not the magic cash generators market mythology would have you believe… and, in most cases, you should avoid them.
Do You Have Access To The Best Information?
When highly regarded private companies go public, they attract plenty of media coverage, which generates excitement among investors.
However, getting quality information—the kind you need to make any investment decision—is difficult.
Most of these private companies are operating in new industries, and they keep all the vital information, such as growth projections, for themselves to maintain a competitive advantage.
Moreover, the financial statements they provide usually go back only a couple of years. Uber, for example, has been in business for over a decade, yet it offered statements only for the last three years in advance of its IPO. That’s seven years of missing financial data that could enhance your investment analysis.
What’s even more concerning is that the same rules don’t apply to institutional investors and insiders. The institutional money gets face-to-face meetings with founders, during which they can gain access to information not available to the public.
The Game Is Rigged To Benefit The Big Guys
As part of the IPO process, the company going public hires an underwriter, usually a high-profile investment bank, to determine the offering price. This is also the price that the media quotes in their headlines.
But that’s not the price you can buy at. Again, the big players get an advantage. The underwriter offers the shares to VIP customers, high-net-worth individuals, and other institutions first. They get to buy at the IPO price.
When the shares finally begin trading on the open markets, the price can be much higher. When Lyft began trading, the price was 21% above the IPO price… meaning, the big players made 21% in an instant.
Historically, IPOs Don’t Deliver
Participating in an IPO is risky and should be rewarded by large returns.
Unfortunately, that’s rarely the case. During the last two years, most marquee IPOs have underperformed the S&P 500.
Take Spotify, for example, a famous IPO from 2018. It’s down over 25% from its offering price, while, during the same period, the S&P 500 has gained roughly 5%.
You see the same pattern when you look at other IPOs, including AXA, iQiyi, Snap, and I could go on.
Of course, some of these stocks could recover. Facebook serves as a great example of a failed IPO that later turned around. But it took more than a year for that to happen, and, at a certain point in the meantime, the stock was trading 50% below its IPO price—enough to trigger a stop-loss from most investors.
If you absolutely must partake in an IPO, make sure you’re prepared for the volatility likely to follow.