The Risks And Rewards Of Investing In IPOS
February 20, 2020
Have you ever heard someone touting how they got in on the “ground floor” of a publicly-traded stock and it skyrocketed from there? What did they mean by “ground floor”? Most likely what they are referring to is that they bought a company’s initial public offering (IPO) when the company “went public.”
Initial Public Offering (IPO)
An IPO refers to the process of a private corporation offering shares to the public in a new stock issuance. The primary benefit of going public is gaining access to a world of capital. IPOs often get a lot of attention because they offer new opportunities to invest in exciting, fast-growing companies. But investing in IPOs is also riskier than investing in traditional blue-chip companies. New public issues tend to be more volatile in their first few months on the market as investors dig into the business and attempt to make sense of the company’s valuation.
The Volatility of an Initial Public Offering
Historically, IPOs perform very well on the first day of trading. According to a study done by the University of Florida, IPOs from 1980–2016 averaged a first-day return of 17.9%.
How a company performs during its first day, or even during its first year, is not always indicative of long-term performance. Take Facebook, for example, whose IPO price was $38 per share on May 18, 2012. On Facebook’s first day of trading, returns were essentially flat, while later that same year the stock hit its all-time low of $17.55 per share. As of January 6, 2020, Facebook trades at $212.57, a 459% return on its IPO price seven years ago (Yahoo Finance).
On the flip side, we have GoPro. GoPro develops and sells cameras, drones, and mountable and wearable accessories. It had its IPO in June 2014 at $24 per share. GoPro’s stock price closed its first day of trading at $31.34 per share, closing up over 30% on its first day of trading! The rapid climb continued into October 2014, when GoPro peaked at $98.47. However, as of January 6, 2020 GoPro trades at just $4.46, a -81% return on its IPO price (Yahoo Finance).
Big Name “Disruptor” IPOs
More recently, the 2019 IPO calendar was crowded with big name “disruptor” companies such as Zoom, Lyft, Peloton, and Uber. Two big name IPOs of 2019 that I want to focus on are Uber and Zoom. One of them has been very successful so far in the public markets, while the other one has been struggling.
Uber had an IPO price of $45 per share in May 2019, and as of January 6, 2020, Uber trades at $31.58, a -29% return on its IPO price (Yahoo Finance). By comparison, Zoom Communications, a company that provides remote conferencing services using cloud computing, has been very successful since going public. Zoom had an IPO price of $36 per share in April 2019, and as of January 6, 2020, Zoom trades at $70.32, a 95% return on its IPO price (Yahoo Finance).
What to Keep in Mind about IPOs
It’s important to remember that a company’s first-year performance in the stock market is not always indicative of what its long-term results will produce, as we learned from the trials and tribulations of companies such as Facebook and GoPro. It can take time for a company to find its footing. It’s critical to not overreact to wild price swings in the first year of trading. Remember, if it’s a solid business and you’re investing for long-term price appreciation, it is imperative to stay the course and not get emotional over short-term returns or losses. This way of thinking not only applies to individual stocks, but diversified portfolios as well. In the wise words of Warren Buffet, “The stock market is a device for transferring money from the impatient to the patient.”
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