As an editor of Wall Street’s Best Investments, I often get questions about IPOs. Buying IPOs is in vogue again. The 2017 U.S. Initial Public Offering (IPO) market looks to be in revival mode, with—so far—115 companies issuing stock for the first time this year. That number has already surpassed the 98 companies who brought their shares public in 2016, which was the second year in a row that IPOs were down. From 2012-2014, the IPO market saw an average of 138 new issues annually.
But the economic malaise after the recession temporarily stalled the IPO market. That appears to be changing—and not only in the U.S. Globally, 772 companies went public in the first half of the year, raising US$83.4 billion.
In 2017, the majority of IPOs are in the biotech, technology and financial industries, sectors that are outperforming so far this year.
Usually, IPOs create lots of investor excitement. I clearly recall the big hoo-hah over Boston Chicken, when the stock soared 140% on the first day of trading. And do you remember Twitter’s (TWTR) debut, as we all scratched our heads at the 80% gain? But, alas, the IPO debuts of many high-flyers don’t often live up to the hype. After years of struggling, Boston Chicken was bought out by McDonald’s (MCD) in 1999, and as we know, Twitter is barely keeping its head above water these days.
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Motley Fool just released a couple of articles discussing the Best and Worst IPOs of all time:
Best IPOs Ever
Mastercard (MA) – public at less than 4 per share (split-adjusted) in 2006, today the stock is trading at 129 or so.
Alphabet (GOOG) (GOOGL) – GOOG shares IPO’d in 2004 at 85; it’s trading now at 972.
Facebook (FB) – debuted at 38 in 2012; now, it’s trading at 164 and change.
Worst IPOs Ever
eToys – went public at 20 in 1999; began liquidation two years later
Pets.com – liquidated 268 days after its IPO
Groupon (GRPN) – had the misfortune to go public during the recession, in November 2008. The stock opened well at 20, sales were booming, then the economy shot it down. Today, it is still regrouping and is trading at 3.65 as I write this.
And this year’s IPOs haven’t been all roses, either. Two highly-touted companies—Snap Inc. (SNAP) and Blue Apron Holdings (APRN)—have both disappointed investors. SNAP IPO’d at 17 per share in March, and is now trading at 13.81. Likewise, APRN went public in June at 10, and at last look, was floundering at 6.74.
Yet, the possibility of finding another Facebook or Google continues to enthrall investors.
For the average investor, there are two important questions when it comes to initial public offerings:
- How do I get in?
- How do I judge which companies are worth my investing dollars?
Buying IPOs: How it Works
First of all, buying IPOs isn’t that easy. That’s because brokerage firms generally reserve most of the shares for large institutions and the underwriting firms’ well-heeled clientele. Your first point of contact is your broker to see if his company will have any shares to distribute to their clients. Next, call the Investor Relations department of the company that’s going public to find out if it is going to issue any shares directly to the public, and lastly, you can try contacting the underwriters of the stock and ask how they intend to distribute shares.
Here are a couple of links to upcoming IPOs:
http://www.marketwatch.com/tools/ipo-calendar
http://www.marketwatch.com/tools/ipo-calendar
But the real question should really be, should I buy shares right away or wait? And that’s where you need to put pencil to paper (or in this day and age, fingers to your keyboard!).
Analyzing IPO Companies
Sure, you could get really, really lucky and buy the shares of an IPO that skyrocketed the first day, sell the shares at the end of the day, and walk away with a pocketful of money. It does happen, but not normally to regular investors like you and me. Instead, we need to rely on old-fashioned gumshoe work, viewing the IPO issue as we would any other investment, and asking ourselves, is this stock worth adding to my portfolio?
That means a bit of analysis, starting with the company’s financials. Is it profitable? Does its cash flow cover its outlays? Does it have substantial assets (especially cash) and reasonable debt, in case of a downturn in the economy, its sector, or the company itself? If the financials look good, the next step is to examine the company’s products or services and determine if they meet a real, ongoing need. You can see that fairly easily by looking at its past growth and future projections, which should be included in the prospectus in the proforma financial statements.
If the company passes your tests, you may want to wait a bit to buy in, even if you could buy shares on the first day of trading, because prices of IPOs often fall precipitously shortly after the stock debuts. And many continue to decline.
On average, IPOs—according to Barron’s research—can underperform up to 2 ½ years after their initial pricing. And according to IPOScoop.com, of the 131 IPOs in the past 12 months, two are still trading at their IPO price, 44 below the IPO pricing, and 85 are in the black.
But the following graph demonstrates the risk of buying IPOs better than mere words. It is a comprehensive study by Equities Lab of all IPOs since 1998. The brown line is the S&P 500’s performance; the green line belongs to IPOs. You can easily see the tech boom since the late 1990s in the spike on the graph. That’s when companies were issuing shares of technology companies at a supersonic pace—and most of those companies have since failed.
Since then, IPOs have mostly followed the same cycle as the S&P 500—just not as profitably. Bottom line—on average, you would have made more money by investing in an S&P 500 Index than buying IPOs, for a time period of almost 20 years.
Source: Equities Lab
Of course, this graph depicts averages and there have certainly been plenty of winners in the IPO market. But investors must tread carefully when buying IPOs.
The good news for the IPO business right now is that valuations are much more reasonable than they’ve been for years. So, perhaps that means the trading ranges won’t be quite so volatile and the after-IPO underperformance period might decline. But it also means that some companies—especially in the energy industry—are delaying their IPOs until prices improve.
Nevertheless, the key to successful investing is buying the right stocks at the right price, fundamentally strong companies that have the ability, strategy and good management to continue growing over the long-term.
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