Last week was a busy week as far as new companies going public.
What is an Initial Public Offering (IPO)?
When a privately held company starts selling stock to outside investors, making it a public company.
As small companies start to gain traction, they may need outside financing to continue growing, and decide to go public.
It can be a long and complicated process transitioning from a private to a public company. To name a few reasons: the company now has investors that can vote on the direction of the business, it’s now regulated by the Securities and Exchanges Commission (SEC) and has to follow more strict accounting procedures under Generally Accepted Accounting Principles (GAAP) .
So what does this mean for individual investors like you and I?
This means that investments in companies which had previously been unavailable are now able to be purchased. But is it smart to invest in IPOs? We’ll get to that in a minute.
Which companies have recently gone public?
Snap – I wanted to highlight Snap first because I know a lot of millennials who thought this was going to be the best investment ever. You know, the company behind SnapChat? On the first day, in March 2017, it jumped from $20 to $30 and everyone wanted in on it. But since then the stock price has consistently fallen to a price of now $11.48 as of writing. That means you would have now lost 61% of your investment if you bought snap on the first day and still owned it.
Spotify – Spotify is another example of a company going public that hasn’t worked out too well. They have lost nearly 17% since going public last year in April 2018.
Lyft – Lyft just recently went public on March 29th, 2019 and is another example of why investing in IPOs can be really risky. Lyft started selling at a price of $87.24 and it’s now at $59.39. That’s a 32% loss if you had invested money on the first day. It’s still too early to tell what will happen to the price of Lyft, but I’m predicting the price will continue to go down because is all Uber has to do is set their price lower and everyone will start flocking to Uber.
Uber – Uber has not officially became a public company yet but it’s right around the corner. Analysts are predicting the share price to be lower than Lyft’s but may be the biggest one of 2019.
Pinterest – Pinterest went public last week and I’m sure you’ve heard of them. Their share price was listed on the New York Stock Exchange on April 18th at $23.75 and has gone up 3%. It’s still too early to tell what it will do.
Zoom – Lastly, Zoom is a video conferencing platform that also went public last week and saw some growth on the first day. Both Pinterest and Zoom went public on Thursday and since Friday was a holiday have only had one day of trading. This week should be interesting to see what happens.
Should you invest in IPOs?
Though IPOs can be good for the companies behind them, they’re not always great for investors — especially the inexperienced kind.
I’m not going to say that IPOs are always a bad investment, especially if it’s a company that you know, like and trust.
But I have to give a word of caution and say most of the time they’re just too risky and you’re better of investing in index funds.
I’m going to give you five things to consider when it comes to investing in IPOs.
5 Things to Consider
1. Don’t just follow the crowd
Going back to our Snap example, this is a good example of avoiding the herd mentality. Just because everyone is buying the stock does not make it a good investment.
2. Avoid them for the most part
Investing in individual stocks requires a lot of work and may not yield the best results. No one really knows what the share price of a company is going to do after an IPO and you’re safer avoiding them all together.
3. Pay attention to the financials
If you are going to invest in an IPO make sure to do your research and don’t just do it because it’s a cool company and your friends are doing it. Read over the prospectus which you can find on the SEC’s website. You should be able to explain your reasoning if you do buy a new company’s stock.
4. Be ready to lose money
Be ready to lose the money that you invest in an IPO. If you can’t afford to lose it then you shouldn’t consider investing in new companies. You’d be better off keeping the money in savings or paying off debt.
5. Consider investing in index funds
It’s hard predicting when to buy a new company’s shares and what’s even harder is knowing when to sell. Because of the added and unnecessary stress, it’s best to stick to a strategy that will allow you to sleep better at night and will most likely be more successful in the long run.
And that’s investing in thousands of companies at once. Take the S&P 500 for example. This is a benchmark made up of the 500 biggest US companies based on market capitalization. So if a new company has a market cap big enough to be in the top 500, one of the companies falls off and the new company is added in. So if you own a similar index fund you may be investing in the new company just with less exposure allowing you to avoid unsystematic risk.
You have a lot to consider when investing in IPOs and nobody likes FOMO. Do your homework and decide if investing in individual stocks aligns with your goals.
