2019 is the year of IPOs, with numerous high-profile companies going public in the past few months.
The question on many people's minds is: are these companies worth the investment?
Let’s talk about what IPO stocks are, some of the most recent IPOs and whether or not you’re missing the boat on buying Lyft, Uber or Snapchat.
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IPO stands for initial public offering.
An IPO takes place when a private company offers shares for sale on the public market for the first time.
While a company is private, the sum of its stock is typically held by the few owners of the company, and that stock is not available for purchase on the stock exchange.
After an IPO, shares of the company's stock can be bought and sold by the public.
In some cases, IPOs can be very high-profile events. This year has already seen several major companies go public for the first time, with IPOs of 2019 including Pinterest, Lyft, Uber, Levi Strauss, and more.
Are IPOs Worth The Investment?
When well-known companies like these become available to purchase on the stock market, many investors quickly start reaching for their wallets.
But, are IPOs really worth investing in, or do they present more risk than reward?
There's no denying that it’s exciting to see a well-known company, such as the recent IPO Uber, become available to purchase.
In most cases, however, IPOs don’t make good investments - let’s talk about why.
To start, most IPO prices are high out of the gate, and it takes some time for the market to correct their pricing. In addition to having a history of being overpriced, most IPOs also experience a steep downturn after their lock-up period expires.
During an IPO's lock-up period, company insiders sign an agreement saying that they will not sell their shares in the company until a certain amount of time has passed.
Once this lock-up period is over, though, many company insiders rush to sell their shares, driving the price of the company down in the process.
More important than all of this, though, is the fact that it is incredibly difficult to analyze whether or not an IPO is a good investment.
This is simply due to the fact that the company has not been on the market long enough to build up historical data. When we invest in a company, we want to be sure that we understand everything there is to understand about it. If we don’t, we shouldn’t be investing in it.
I like to call it, knowing what you don’t know.
Predicting how a company is going to perform in the future when you have no past performance to analyze, is even more challenging.
Rule #1 investing dictates that it is best to purchase companies that have been around for at least ten years, and most IPOs fall short of this benchmark.
Applying the 4M's Method to IPOs
If you are considering investing in an IPO, you should still try to analyze the company using my 4M's method.
If you can’t answer all of the questions confidently, then it probably isn’t a good a good idea to invest your money in it right now.
It's difficult to say whether or not a company has good management when that management has never led the company while it was public.
It's even more difficult to determine whether or not a company presents a margin of safety when it is too new to the market to accurately pinpoint its true value.
Even determining if the company has a moat can be challenging with an IPO since publicly traded companies face a different type and different level of competition than they did when they were private.
None of this is to say that IPOs are bad companies. After all, every company on the stock market had an IPO at one point in time.
It is to say, however, that investing in a company right out of the gate is typically not a great decision.
If you are excited about a new company and think that it is worth investing in, there's no harm in putting it on your watchlist and waiting for a deal.
Invest in a company whose meaning you understand well enough to know you like it for the long haul.
Be patient.
Simply sitting on the sidelines for a while and observing a new company's performance on the market can enable you to make a far more informed decision than you would be able to make right out of the gate. Use logic here and not emotion and think long-term with your money.
Now I’d love to hear from you. Have you ever invested in an IPO? How did it go for you?
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