IPO’s are Horrendous to Buy Right Out of the Gate

IPO’s are like shiny new toys for investors who want something new and exciting. Especially as these companies are big, the anticipation of them going public has had many people itching to get in on the ground-floor. While many have been successful, such as Beyond Meat this month with a staggering gain of over 160% on its first day of trading, so is not the case for many other stocks making their debut.

If Lyft did anything this year, is prove that buying an IPO right out the gate might be one of the worst things a trader can ever do. The company’s IPO was a disaster and shares have fallen over 30% since their debut in March. Analysts have shared concerns over the company’s uncertain path to profitability and the competitive environment dominated by rival Uber.

Berkshire Hathaway’s Warren Buffett said to CNBC’s Becky Quick earlier this year that investors shouldn’t buy “hot” IPO’s. Buffett remarked, “Buying new offerings during hot periods in the market is not anything the average person should think about at all.”

The Oracle of Omaha also once wrote in a 1993 letter to shareholders, “intelligent investor in common stocks will do better in the secondary market than he will do buying new issues… market is ruled by controlling stockholders and corporations, who can usually select the timing of offerings or, if the market looks unfavourable, can avoid an offering altogether. Understandably, these sellers are not going to offer any bargains, either by way of public offering or in a negotiated transaction.”

IPO’s are tricky beasts as it is hard to analyze them. There is no historical stock information to go by as they are brand new. All you have is the company’s prospectus to analyze and make judgement on.

Often traders will look to the performance of similar companies who are already public for comparison purposes, but this is not a good point of reference.

It’s also important to see the quality of the underwriters on the IPO as well as comb through the specific details of the deal. Bigger brokerages tend to promote successful IPO’s over smaller investment banks.

One major reason a company decides to list on a stock exchange is to allow its current investors (think founders, private equity firms, and large individual investors) to “cash out” part or all of what they have invested. This means the IPO’s may be sold at higher prices than their economic value.