Should You Invest in IPOs?

Proj Omni | Jan 04, '17

One question we often get from retail investors is, what should I think about to figure out whether to invest in an IPO? 

First, do the due diligence for IPOs as you’d normally do for other investments.  You'll need to understand the business fundamentals: what the company does, the product, the business model, customer segments and sales (both current revenue and sales projections).  Then you'll need to understand how richly is the company valued--what is the share price and how do the valuation ratios (e.g., Price/Sales, PEG) compare to those of other companies in the industry.  All of this may be a tad more difficult to find for privately held companies that haven’t IPOed yet.     

Second, are you planning to invest in the initial public offering or buy the stock post-IPO?  .  Investing in the initial offering may provide a significantly different return from purchasing shares of a company that recently IPO-ed.  If you’re considering an IPO investment, we strongly encourage you to read the latest SEC filing, investor presentation, and offering summary thoroughly.  At Finstead, we don't recommend a participation in any upcoming IPOs, since they carry a higher amount of risk.  Even when the IPO goes forward and the shares begin trading, the float can be small and shares possibly illiquid.  This adds risk to the investor.  If you’re interested in IPO investments, speak with your broker or check out the offerings at Motif Investments and Loyal3.  

Investing in recently IPO-ed companies gives you more time to do better due diligence before jumping in with both feet.   On thing you may want to avoid is buying the shares on the first day of trading.  When SnapChat goes public, you may be tempted to buy it on Day 1 (chances are, as a retail investor, you won’t have much access to an event that’s looking like an over-subscribed IPO).  But rather than investing right away, you may want to wait and see how the stock performs, due your thorough research in the meantime, and pull the trigger when you’re ready (and hopefully buy at a lower price than Day 1 close).  Even the largest and most successful IPOs had dipped before they headed up north.  To illustrate this point, check out the price charts for two largest IPOs of 2015: First Data (FDC) and Tallgrass Energy GP (TEGP).  

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Or even Facebook (FB).  Remember there is likely to be a point in time when you’ll be able to acquire the stock at a more favorable price than Day 1 IPO close.

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