How to Trade IPOs

If you want to invest in a new issue or trade an IPO, here’s our quick guide

An Initial Public Offering (IPO) is one of the most exciting events in the life any company. Owners sell shares to the public to raise funds for expansion. In exchange, new owners participate in the Co’s new exciting future.

What should you look for in an IPO?

Uber (UBER), the behemoth tech taxi, listed last week in the US amidst a great fanfare. Its competitor, Lyft (LYFT), was also listed earlier. Some other interesting US IPOs recently were Zoom (ZOOM), Beyond Meat (BYND), Tradeweb (TW), Pinterest (PINS), among others.

However not all investors like IPOs. “In 54 years,” said Warren Buffett recently, “I don’t think Berkshire has ever bought a new issue.” The reason? Animal spirits and selling incentives. The fact that IPOs are “going to be better than 1,000 other things I could buy where there is no similar enthusiasm … just doesn’t make any sense.”

However, the masses – and Wall Street – still like IPOs. When animal spirits are bullish, you can’t keep it down.

Where to invest in IPOs

If you are based in the UK you can invest in IPO’s through any decent stockbroker. Most new digital investment platforms don’t provide access to new issues so you can compare those that do in our stockbroker comparison table.

Or find out more about these stockbrokers that offer access to IPOs:

Should you wish to participate in newly-listed companies, here are five key questions you should ask before plunging in:

Five Things to Look For in an IPO

1) What’s the story?

Every new company has a good story to tell. What’s the vision? Is the sector a completely new one? Two decades ago, dot-com firms were all the rage. Now, payment, AI, cloud, automation, robotics are some of the hottest sectors. These fads do not last forever.

Look at the Cannabis sector. Tilray (TLRY) went ballistic last year amidst expectations of legal changes in some countries.  Prices shot up 15x post-IPO in just three months! But prices have corrected by more than 70% from its $300 peak (see below).

2) Is the firm making money?

Many new IPOs are not profitable. This could impact the valuation of an IPO. However, being lossmaking does not mean its share price will go down. A related question is: Will the firm use the IPO proceeds to expand, reduce debt or conduct some other activities?

If investors think a firm’s current losses can be financed by its internally or that its cash needs are not very high, its stock price may still rally post-IPO, especially if the IPO pricing was not aggressive.

For example, PagerDuty, an unprofitable cloud-based B2B tech firm, remains in a firm uptrend after its IPO (see below).

3) How did the previous IPOs perform?

This is an important question because it is about investor psychology. Investors are more likely to buy more if prior IPOs were hugely successful.

Lyft’s persistent price decline post IPO – in excess of 40% – has dragged Uber’s valuation lower (see below). Short-sellers saw the chance to pounce on its next victim after scoring success in Lyft. And they did.

4) End-of-Cycle IPOs? 

IPOs are a product of a strong bull cycle. Demand is stronger in this phase; valuation higher. That’s where the danger lies. Investors and traders can make lots of money ‘flipping’ IPOs during a mania (eg the dotcom boom in the nineties). But once the speculative mania ends, many IPOs went bankrupt. You need to be able to know, roughly, where the cycle is now.

Expectations matters too. An IPO with low expectations may perform better one with high expectations.

5) Do you have a plan to trade IPOs? 

Strict discipline in buying and selling IPO shares is essential. A stop loss is a must because prices could move anywhere in its early days. It may double – or halve. Holding for the long-term requires a stop too. Take Snap, $25 to $5 in 18 months.

From experience, the best IPOs are ones that are listed in the early phase of an economic upswing because valuation are not excessive and expectations are low. Buying at the end of the cycle entail higher risks because more things could go wrong.

 

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