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What to Look for When Deciding to Invest in an IPO

Written By Gary S. Williams, CFP®, CRPC®, AIF® and Nicholas A. Ibello, CFP®, AIF® February 27, 2019

When a privately held company issues its stock to the public for the first time, the excitement is often palpable. An initial public offering, or IPO, can be alluring to investors hoping for a chance to purchase a new stock before it takes off. 

But getting in on the ground floor has its risks. High demand doesn’t always mean a stock will be a winner — the IPO market always generates some washouts. Does that mean investors should ignore IPOs? Not necessarily. But it does mean that IPO investors should recognize the risks and keep a clear eye on fundamentals such as revenue, expenses and earnings.  That isn’t always easy to do, because by definition, newly public companies might not have years worth of audited financial statements available to investors.

IPO activity intensified in 2017 after relatively weak activity in 2015 and 2016. In all, 160 IPOs were priced last year, up 52.4 percent from 2016, and the proceeds from these IPOs jumped to $35.5 billion, up 88.8 percent, according to Renaissance Capital. Meanwhile, IPO returns outperformed the S&P 500 in 2017, averaging returns of 27 percent at year-end versus 19 percent for the stock market benchmark, according to PwC US Capital Markets Watch.

The outlook remains positive this year, as well-known companies such as Spotify, Dropbox and DocuSign have come off the sidelines to be listed on stock exchanges. Lyft and SurveyMonkey are among the companies reported to be planning IPOs this year, and Airbnb and Uber have said they are preparing for listings in 2019. Closer to home in Howard County, Tenable Network Security is reported to have hired an investment banker to prepare for its IPO in 2018.

Individual investors who want to participate in IPOs should get familiar with the process. Interested investors must be registered with a brokerage firm since companies that issue IPOs notify their network of brokerage firms, which then notify investors. Most brokerage firms require investors to meet financial qualifications to participate in an IPO. For example, a firm might require investors to have minimum assets of $100,000 or even $250,000 in a brokerage account.

Investors also need to recognize that wanting a piece of an IPO and getting it are different things. IPOs almost always have a limited number of shares up for grabs, and some willing investors can get cut out when demand exceeds supply, resulting in an “oversubscribed” IPO.

Identifying companies and sectors to invest in is another important planning step. Companies that intend to go public file a Form S-1 with the Securities and Exchange Commission. Recently, these filings have been dominated by technology, health care and financial companies, but consumer products are gaining traction. In April, beanbag-furniture manufacturer Lovesac announced plans for a $46 million IPO. Investing in companies that you understand is always a good starting point, and investors may find it helpful to narrow their choices.

Investors also shouldn’t jump in without taking a clear-eyed look at both the risks and the fundamentals. One risk that is easily overlooked is that IPOs transform privately-controlled companies into public companies, which must then cope with increased scrutiny and accountability. Such a cultural shift can be tricky to navigate. 

Finally, focus on investing basics.  Is the future-IPO company making a profit, or is it on a clear path to do so? Are its revenue trends favorable and sustainable? How well is the company controlling expenses? What competitive pressures does it face? How easily could it be eclipsed by a newcomer? Is tomorrow’s IPO nipping at its heels?

Let the CERTIFIED FINANCIAL PLANNER™ professionals at Williams Asset Management help with your wealth management needs. Whether you need comprehensive and holistic financial planning or investment management, we can help!  We are fee-based, independent financial advisors located in Columbia, the heart of Howard County, Maryland.  Schedule your complimentary consultation today by calling (410) 740-0220!