New Stock Offerings: What to Look for

Proj Omni: Jan 11, '17

In the previous post we discussed whether you, as a retail investor, should even consider investing in IPOs.  You carry a great deal of risk when you invest in mature stocks, but new offerings can be even riskier.  If you’re a daredevil and you’d like to buy a newly IPOed stock, here are a few things you should know before making a decision:

1.  Newly issued stocks can rise and fall insanely fast.  This is particularly pronounced for those stocks that show an exceptional earnings and sales growth, or have steep growth projections.  The demand for the stock driven by hedge and mutual fund managers, along with other large institutional investors, can drive the stock price up to irrational valuations. 

You may remember that Google (GOOGL) rose quickly upon the IPO and gained over 300% in 15 months.  But new issues can also be quite volatile, and not all of them generate such impressive gains. Facebook (FB) and Alibaba (BABA) are examples of high-profile new issues that initially struggled.

2.  Since much of the valuation depends on the revenue and earnings growth expectations, it’s important to understand what those growth projections are, and how the company has performed thus far.  Do you think the company can realistically beat the expectations?  Are the growth projections too aggressive or too conservative?  Beware of hypes--remember how GoPro (GPRO) tanked when the disappointing demand culminated in the company’s decision to cut the device price by $100. 

For historical revenue and profit growth, you can check out Finstead charts and see how those rates compare to the average industry/sector and competitor growth rates.  Below is an example of Coupa Software’s (COUP) quarterly revenue growth performance, relative to the industry and sector peers.

3.  Next, you should understand that short positions are driving stock’s volatility.  The general rule of thumb is, the more shorted a stock is, the more volatile it is likely to be.  Short sellers are predominantly short to medium term traders, unlike long-term investors who are willing to ride out multiple ups and downs in a stock. Therefore, short sellers are generally price sensitive. Short trades are taken on margin, so if the stock goes significantly higher against a trader’s short position, he or she may be required to put up more capital or liquidate the position.  Such pressure causes many traders to panic and buy to cover their position. This mass exodus of short positions causes a lot of buying, in addition to the buying that spooked the short positions in the first place.  Therefore, a short squeeze is when a high number of short positions in a stock are muscled by the buyers into covering their short positions for fear of big losses. This causes a sudden jump in the stock price, so expect more volatility.

You can check the Short Share of Float on Finstead to get a sense of the volatility you may see down the road.  See examples below for Coupa (COUP), a stock that’s less shorted than a typical stock, and Twilio (TWLO)--a stock where short sellers prevail.

4.  Lastly, while you’re looking to formulate your own thesis about a new offering, you may benefit from reading different investors’ views on the newly IPO-ed stock.  We checked out what financial bloggers are saying about Twilio (TWLO)... as you get imagine there are a plenty of bulls and bears.  The bears claim that “Twilio is losing money and has poor revenue diversification… with a large customer base, but poor revenue performance,” while the bulls point out that “those short positions in millions of shares of Twilio stock have to be closed out without any help from a wave of insider selling.” 

We’re hoping that you will continue to evaluate the parameters relevant for new offerings if brand new IPOs are of an interest to you.  IPO investment decisions are super risky relative to more mature stocks, so take the time to understand the company, performance, projections, and what may be driving the stock price up or down.  And invest only after you’ve completed your due diligence!    




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