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The ins and outs of IPO investing

October 30, 2019


Kristen Lunman

Written by Kristen Lunman

Kristen is General Manager of Hatch - a digital investment platform that gives New Zealanders access to the US share markets. Powered by Kiwi Wealth, Hatch provides easy, affordable, and reliable access into the largest, most liquid share markets in the world.


Hatch GM Kristen Lunman takes a close look at the good and the bad, and the ins and outs of IPO investing.

 

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After years of sporadic initial public offerings (IPOs), 2019 is set to be a banner year for well-known billion-dollar companies hitting the US share markets. More than 200 private companies (100 of them, known as Unicorns, worth over $1 billion) were in the IPO backlog - record highs the market hadn't ever seen before. 

What's going on? Compared to the past, companies are staying private longer and are worth more than ever. Now they're seeking deeper pools of money to fund their appetite for growth.

Whats an IPO?

An IPO is a company's first time offering its shares for sale to the public, known as "going public". In an IPO, new shares are created and sold to raise money for the company. Before the IPO, only a select group of investors can invest. But after the IPO, everyday investors can buy or sell shares of a company through a brokerage platform, such as Hatch.

Hot and not

How have these companies been doing since making their public debuts? Well, it's been a mixed bag. Luckily, many have been helped by a strong share market, so the average first-day share price increase for 42 of these newly listed companies was 22% which is well above the historical average of roughly 15%

But it hasn't been smooth sailing for the Unicorn. Uber, Lyft, Jumia, and Peloton are all down from their IPO prices* and investors have increasingly shown caution with newly listed IPOs from highly valued, loss-making businesses. SmileDirectClub's first-day share price closed down 27.5% from its initial offering price of $23, the worst first-day showing in about two decades among IPOs that raised more than $500 million. Postmates, a food-delivery unicorn, delayed its IPO telling TechCrunch that the markets "are a little choppy when it comes to growth companies." Then there's WeWork. After it was unable to sell to the public on a We listing in September, collateral damage continues with reports that it's planning to lay off up to 4,000 employees following its funding rescue by SoftBank

Maybe it's not all doom and gloom. Everyday investors are showing interest in big-name IPOs they know and use like Pinterest and Slack as well as leading innovators like Beyond Meat, Zoom Video Communications, CrowdStrike, and Cloudflare. Beyond Meat's share price is still up over 117%* since its public debut, even though analysts ruthlessly debate its staying power.

A good indicator of the general IPO market this year is the Renaissance IPO ETF. Consisting of a basket of 60 of the most recent large IPOs, it has climbed more than 21%* since the beginning of the year. Comparatively, the S&P 500 has risen about 19%*. Some of the ETF's biggest holdings include Spotify, Uber, Roku and DocuSign. But buyer beware! Goldman Sachs reported earlier this year that the median IPO share performance since 2010 has lagged behind the Russell 3000 (which tracks the US share markets) by 28% over their first three years of trading.

*As of October 25, 2019

What defines an IPO's success?

Goldman Sachs analysed over 4000 IPOs over 25 years and concluded that certain traits could make or break a newly public company.

1 The sector

during the tech-IPO boom/bust in 2000, close to half of all new listings were either tech or media companies. According to Goldman Sachs, the sector breakdown for IPOs has changed a lot, with tech and media companies only accounting for 19% of new listings since 2010. 

2 Age of company

according to research from Jay Ritter, an IPO expert at the University of Florida, during the tech-IPO boom/bust the median age for tech companies going public was under five years old, compared with 12 years in 2018.

3 The valuation

a growing concern in 2019 is that newly listed companies are too expensive relative to their fundamentals. Analysts have pointed to Uber's lacklustre IPO and recent WeWork IPO backlash as a valuation problem.

4 Path to profitability

according to Goldman Sachs, IPO investors are intently-focussed on when a company will achieve profitability. Once publicly listed, a "grow at all costs" mentality may no longer be as palatable to retail investors.

5 Sales growth

according to Goldman Sachs, sales growth has been the strongest determinant of IPO outperformance. IPOs with annual sales growth greater than 20% year on year have been more likely to outperform the Russell 3000 over three years than a comparable, slower-growing IPO.

 

Thinking about investing in an IPO? Here are four things to consider before investing in an IPO:
 

1 Read the prospectus

The IPO prospectus is a report that shares details of the IPO, the business, and how the money raised will be spent. Remember that while most companies try to disclose as much as possible in their prospectus, it's written by the company itself and not by an unbiased third party.

2 Research, research, research

Getting information on companies about to go public can be a challenge. Unlike most publicly traded companies, private companies don't usually have analysts covering their every move. Even though available info may be limited, learning as much as you can about the company is a good idea. You can still search for information on the company and its competitors, how they've raised money so far, as well as overall industry information.

3 Find out when the lock-up period expires

The lock-up period usually takes three months to two years. During this period, insiders of the company are not allowed to sell shares. Share prices have historically experienced volatility on and around their lock-up dates; however, once the lock-up period is over, the focus returns to fundamentals (and interested investors tend to keep calm and invest on).

4 Approach with a cool head

Scepticism can be a positive strategy when you're considering investing in a newly listed company. There can be quite a bit of uncertainty surrounding IPOs, and as a result, share price volatility. Approach investing armed with information and remember that a good company should still be a good company and a worthy investment, even after the lock-up period expires.

 

If you're interested in recently listed US IPOs, or accessing over 3000 other US-list shares easily and affordably, take a look at Hatch.

 

 

Tags: Economy, Hatch, Investment Basics

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