How and When to Invest in an IPO
There are plenty of IPO investing opportunities on the horizon, use my strategy to avoid the pitfalls.
2019 is primed to be a very compelling year for initial public offerings (IPOs) for interesting companies. We are about to have a whole cast of new unicorns entering the prime grazing ground of the US markets. There are plenty of opportunities to get involved, as well as pitfalls you should be aware of. You have likely heard of recent newcomers including:
Lyft (LYFT), the new age transportation (taxi?) company
Pinterest (PINS), a next generation sales and marketing platform
ZOOM (ZM), a new comer to video conferencing world, with a killer application
BEYONDMEAT (BYND), pushing the boundaries, providing a better way to feed the planet
As well as a few big ones, yet to come:
In complete transparency
I own a number of stocks discussed in this article: LYFT, PINS, AMZN, and FB.
Uber, the ride hailing company, looking to push into autonomous driving, food delivery, smart cities and more.
Slack, the future of business communication: beyond email
Here is the thing, about IPOs:
IPOs are RISKY!
If you buy on the opening day, you only “think” you are getting in early. Most of the “early” shares are allocated to big players.
You may think that you understand the business model, and the goals of the company. But often the long term strategy has not been fully vetted (think Amazon coming out as an online book store, Google as a hopped up search engine and Facebook as a way for college students to connect). Or the long term strategy has not been fully broadcast and understood.
The real numbers behind the business, while private, have not been fully vetted by the market at large.
There are just as many examples of short term flame outs, after IPOs, as there are successes. Recent examples include:
lyft - down from high $80’s to low $60’s in the first month;
Spotify - launched in May 2018 at around $160 and is now at $136;
Remember Facebook’s bumpy first year? It launched in May 2012 at $38 and closed one year later $27.50.
But there are wonderful opportunities in buying stocks of companies at an early point and then holding them for the long term.
Nobody, still holding FB, from the beginning, is fretting about the first year decline, given the current price of $195. Nor are people worried about Amazon starting at $18, now worth $1,900.
The best long term strategy for building wealth is
to invest in a few widely diversified, low cost ETFs.
So how do you approach this delicate situation?
First Know this: The best long term strategy for building wealth, is to invest in a few widely diversified, low cost ETFs. Then continue to buy through the short term, ups and downs of the market.
If your risk tolerance is low, stay away.
Wait until things shake out over the course of the first year or so. This will give analysts the opportunity to dig through the numbers, the business strategy and company leadership. These stocks will also end up in your broad based ETFs. So don’t worry, you will gain exposure.
If your risk tolerance is high,
meaning you can deal with wild swings, you can afford to risk a total collapse in the company and you have some money not currently allocated to your long term goals. I believe there is a way to tip toe into the situation.
How to determine if you should invest in an IPO
You need to have a strong conviction in the company’s business strategy. For example, you believe that meat production, on a world wide scale, is going to lead to a long term detrimental impact to the Earth. And you believe over time, that people will become more open to alternative sources of protein, then BYND may tick this box for you.
You need to have a long time horizon, for the market to completely factor in all of the unknown variables into your company. In the short term, these stocks are going to trade wildly. And are actually a perfect example of how irrational the market is SHORT TERM. For example, it is inexplicable why lyft traded between $58 and $62 last week … there has been NO real new data, at all.
You need to determine how much of your portfolio you are willing to BET on this strategy. You should be thinking < 1%.
You need to have an entry and exit strategy for buying/selling the stock.
How I Invest in IPOs
I buy 1/3 of my allocation, based on #3 above, at the end of the first trading day. NOT at the beginning. The bid/ask will be too wide early, with all of the jockeying. By the end of the day, the day traders looking to cash in on the first day volatility, will be ready to sell. So around 3:30pm, put in a buy order.
Sit tight for, either some set time frame (2 - 5 months), or until there is a major slide in the stock. Many times, reality will set in, people will come to understand that they need to gather some additional information on the company. At that point, the stock will take a breather and potentially drop 10-25%. If that happens, buy 1/3. If the stock goes up or trades side ways, just plan to buy at a set future date.
Set a third time frame, well into the future, like 1 or 2 years. This will have allowed all of the institutional/inside money to exit after the lock up period has expired. And there will have been several quarters of legit reports, that can be used to determine just how serious the company is. Buy your final 1/3 at that date.
Buy and hold. If you believe that the company has a good strategy, and is in a growing market, and has good leadership, your holding period should be indefinite.
When to Sell
Each year, when evaluating your asset allocations, it is a good time to consider how this investment is playing out. Sell if the stock has appreciated and is now a much higher percentage of your overall portfolio, than makes sense.
Sell if the company has taken a strategic direction that is different than your original understanding.
Sell if the company leadership proves unable to keep up with the challenge.
Sell at some set date into the future.
Sell if the stock reaches some percentage of gain/loss, that you are happy/unhappy to have achieved.
If you have a plan, your outcomes will be set and understood, and you will have an opportunity to take the emotion out of this investment.
*** Please, Please PLEASE, don’t check this stock on a daily or weekly basis. The more you check it out, the more likely you will be to get emotional and make a decision counter to your above strategy.
Questions? If you want to talk more, drop me a line, I am happy to provide further clarifications.