At some point in our lives, we all have heard a giddy TV pundit or news anchor talk about a popular tech company completing their “IPO” into the stock market. Recent listings include Uber, Lyft, Snapchat, and Pinterest. But what is an “IPO” and what should be considered before buying a newly listed stock?
An IPO, or initial public offering, is when a private company lists their shares on the public exchange, such as the NYSE or NASDAQ. At this point, the company is considered a public company and investors, such as yourself, are now able to buy shares. But, should you?
There are many things that should be carefully considered before investing in an IPO:
- Timing the Market is Hard: Plan to hold an IPO stock for the long-term to avoid the common large swings in IPO prices during the first year. In fact, according to CNBC, between the years 1975 and 2011 over 60% of IPOs had negative absolute returns. This is due in part to the fact that IPOs are often overhyped, and thus overvalued.
- Know the Company: Make sure you understand how they make money and what their growth drivers will be into the future.
- Be Aware of the Blackout Period: In the months following an IPO, insiders and original investors of the company are often forced into a “blackout” or “lock-up” period in which they are unable to sell their shares. This means that there is less supply of the equity, and thus the price often rises with demand. However, once the period is over and insiders start to sell their shares, there could be significant price movement due to the sudden increase in supply of the stock.
- Rational Over Emotional Investing: Confirm you want to invest in the company for fundamental reasons such as a strong competitive advantage, seasoned management team, or a rapidly growing industry, and not just because of the hype.
- Be Patient: By the time a stock reaches the secondary market, the price is often far above the initial IPO value. Although it may be tempting to buy the inflated stock because you believe it will continue to rise, patience could provide a more attractive buying opportunity in the future.
As always, a conversation with your financial advisor is prudent before taking a large position in any investment – especially newly listed securities.