Five Ways to Assess IPO Stocks
Here's what to look for when considering stock of a brand new public company.
— -- Should you invest in an initial public offering (IPO), the first shares offered by a new public company? A client asked me that question recently. I responded that, as is often the case in investing, this depends on a lot of factors.
IPOs of companies that have acquired pre-launch renown, such as Facebook in 2012 or Alibaba in September 2014, draw a lot of media attention. Media outlets tend to focus on how much company founders profit early on from IPOs, and like to show them ringing the bell to open exchanges, chattering endlessly about their newfound wealth.
But before you get caught up in the glitz, glamor and appearance of easy money, you might want to take a deep breath and wait a bit. An IPO should be researched just as thoroughly as any other company you may be interested in, as it’s easy to make errors that could be hazardous to your wealth.
When deciding whether to invest your hard-earned money in an IPO, you’ll want to look at the sales and earnings history of the company and other fundamental metrics, just as you would a company that has been around a long time. However, buying shares of IPOs is often much trickier than investing in established stocks because there may be limited information available about past sales and earnings – and, some companies go public before ever turning a profit.
As IPO companies are listed on the open market for the first time, they lack performance charts. Chart analysis, or technical analysis, is used by many professional traders and institutional investors, like mutual funds and pensions, to help determine at what price points to buy or sell.
A stock is only worth what someone is willing to pay for it, but at the beginning of an IPO, many times there are more buyers than sellers. Sure, there might be some day traders or other short term stock jockeys that will be looking to get in on the first morning and then sell quickly, or clients of an investment bank syndicate that got an allocation of shares and are looking for a short-term profit. However, many of the early, private investors, employees and other insiders have a lock-up period that governs when they can sell--often, not until 90 days or more post-launch.
Investors with IPO fever often push up the share price steeply in the first few weeks, only to regret this a few months later after the shares dip below what they paid and level off. Regret can turn into remorse when this plateau persists.
You can significantly lessen the chances of having this remorse by developing a sound process for evaluating IPOs – one that’s based not on irrational exuberance but on an understanding of the peculiar dynamics of this unpredictable embryonic period of new public stocks.
Here are five points to keep in mind when considering IPOs:
- Ignore the hype. In the weeks preceding an IPO, you’ll see numerous articles speculating on how well they’ll do. While this information sometimes has value, it may be skewed toward cheerleaders who seek to profit from the initial offering.
- Instead of absorbing this hype, do some objective research on the company. Do its reasons for existing involve an investible proposition for the long term, assured by sustainable markets for its products or services? What competitors are there and how easy is it to enter the business? What do its pre-IPO SEC filings reveal about its financial condition? These filings can be found using the search function on the SEC filings site.
- Don’t be in a hurry. You don’t have to buy on the first day. There’s a widespread misconception that if you don’t get in on day one, you’ll miss out on the “magic.” But for the average investor, jumping in too early more often brings missteps than magic. It’s better to wait a while--until there’s some chart history indicating how the offering is faring.
- Determine the lock-up period. You may be better served to wait until after the lock-up period is over. For example, if the stock tanks in the weeks after the lock-up expire, it could mean that the insiders are selling their shares. While some selling is normal, a fundamentally strong stock will usually bounce back quickly as institutional investors snap up these shares. If too few buyers come in to support the stock, then you may decide it’s not worth owning anyway. If enough of these employees cash in, shares might flood the market after the lock-up period, driving down price.
- Let things settle out. Wait for the IPO to settle into some kind of chart pattern that you can analyze to determine the best time to get in – if at all. The course of some recent high-profile IPOs underscores the need for a cautious evaluation process for investors.
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