Should You Invest in an IPO?

Bill Parrott |

We like shiny new objects. For investors, the object is the initial public offering or IPO. Getting in on the ground floor of a hot offering is a huge draw. A few high-profile private companies are now publicly traded. Companies like UBER, Pinterest, Slack, Lyft, Chewy, Beyond Meat, Levi Strauss, Zoom Video, Smile Direct, and Peloton are now trading publicly. How have they performed?[1]

  • UBER = Down 24%
  • Pinterest = Up 11%
  • Slack = Down 41%
  • Beyond Meat = Up 110%
  • Lyft = Down 47%
  • Zoom Video = Up 28%
  • Chewy = Down 23%
  • Levi Strauss = Down 16%
  • Smile Direct = Down 13%
  • Peloton = Down 7%

According to CNBC, 120 IPOs have come public this year, and 57 are trading down, 48% of the issues are trading in negative territory.[2] Not all IPOs are bad, of course, as Coke, Pepsi, McDonald’s, Starbucks, Home Depot, Costco, Walmart, Amazon, Apple, and Google have performed well over time.  

When a company issues shares to the public, the founders and early investors are cashing out. Companies hire investment banks like Goldman Sachs or Morgan Stanley to help sell and market their shares. The banks conduct roadshows to introduce the company to investors and receive indications of interests. If you’re lucky, your broker will give you a few shares of the offering. Once the deal closes, the stock will start trading on the open market where investors who weren’t able to get shares during the offering phase can now purchase the stock.

For Example, the IPO price for Beyond Meat was $25 per share. It started trading at $46 and quickly popped to $72.95 before closing at $65.75. The founders, owners, and early-stage investors were in well before the offering. Investors in the IPO received shares priced at $25. The public was able to buy it between $65.75 and $72.95. On the first day of trading Beyond Meat soared 192%! However, only the early-stage investors and IPO participants realized this gain. If you bought it at the top, you lost about 10% on the first day.

The IPO market is reeling because of the poor stock performance of Peloton, Uber, Lyft, Slack, and a few other high-profile names. As a result, We Work, and Endeavor Group Holdings canceled their offerings. Endeavor has sited “weak stock market demand” as a reason for suspending their IPO launch.[3] We Work, on the other hand, will be a Harvard Business School case study someday on how not to handle an IPO. Investors grew concerned with the company’s valuation, the CEO, and the lack of profitability. Since We Work announced they’re terminating their IPO, the CEO has stepped down and the company may lay off one-third of their workforce.

Mutual funds and large institutions are significant players in the IPO market, and some are speculating that they may forego investing in IPOs in the future because of the recent poor performance. Don’t hold your breath. Do you remember the Tech-Wreck? From April 2000 to October 2002, the S&P 500 fell 44% because of the extreme valuation in technology stocks, and the feeding frenzy with IPOs. Investors bid up the prices of, eToys, and Webvan only to have them evaporate into thin air a few months later. Despite the disastrous performance of the IPOs in the early 2000s, large institutions are still investing in new offerings.

I worked at Morgan Stanley during the insane days of IPO listings and investors couldn’t wait to buy a new offering regardless of what the company did or where it would price. They didn’t care because their intent was to flip the stock as soon as possible and pocket big money. This strategy worked until it didn’t. Tulip Mania?

Should you invest in IPOs? Most brokerage firms have strict policies on who gets shares. You won’t be able to cherry-pick the best stocks and you’ll be forced to buy both good and bad names. And most allocations to retail investors are small. In a hot IPO like Peloton, you may only receive 25 shares. If you want to participate in this arena, limit your allocation to 3% to 5% of your investment capital.

Shiny objects eventually fade, but speculators will always be attracted to peddlers promising short-term gargantuan gains. If you’re late to the party, you could lose a significant amount of money.

Be careful. Do your homework. Invest wisely.

What has been will be again, what has been done will be done again; there is nothing new under the sun. ~ Ecclesiastes 1:9

September 27, 2019

Bill Parrott, CFP®, CKA® is the President and CEO of Parrott Wealth Management located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level.

Note: Investments are not guaranteed and do involve risk. Your returns may differ than those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren’t suitable for every investor.




[1] YCharts

[2] CNBC, Carl Quintanilla Twitter @carlquintanilla, September 26, 2019 @ 10:54