Are IPOs a good investment?

Are IPOs a good investment?

With the headlines of prominent companies such as Reddit seeking an Initial Public Offering (IPO) in 2024, investors may wonder if these are opportunities or risks to their portfolios. 2021 saw the most IPOs this century, with over 1000 IPO’s occurring in that year alone – more than double the amount seen in the past 24 years. While IPOs can be exciting events, they often result in a disappointing short-term investment for individuals and their personal financial plans.

Since 2021, the U.S. has seen the lowest rates of IPOs since the great financial crisis and 2016. This is in part due to IPOs preference to go public during bull markets and near or at market all-time highs. This is because a company may receive a higher valuation which results in more capital investment in the company. While this makes sense from a company perspective, it is at odds with investment principles of “buy low, sell high” the company is selling itself at a high to investors willing to buy at a high – which is not always the best time to purchase shares. IPOs may not be the best decisions or portfolio strategy for your personal financial plan.

While some IPOs have been fabulous long term success stories (Apple, Nvidia and even Monster Energy) the majority have been poor investments. Three years after their IPO, 64% of companies underperformed the broad market by more than 10%. Additionally, the rate of unprofitable IPOs since 1980 has risen from roughly 20% to 80%.

While promising companies may not be profitable at first, understanding the inherent risks associated with making any investment decisions is very important. For instance, electric vehicle sales have been on a steady rise, but operating a profitable publicly traded electric vehicle manufacturer is not necessarily directly correlated to EV demand. Rivian is a prime example of this. The company’s highly anticipated IPO in November of 2021 has not reflected the trajectory of Tesla. Rivian’s stock price is currently sitting more than 90% below its IPO value as of February 23, 2024.

While IPOs can “pop”, and experience large returns in the first day of trading, “lock up” periods that affect members of the company and initial institutional investors can artificially hold prices up until the lock up period ends. Once this happens, investors who may have wanted to sell shares but couldn’t are now able to unload their holdings. If enough people decide to sell, this can increase the volume of trading and begin to push prices down. This in part contributes to some IPOs looking attractive initially but reflecting disappointing, deep declines not long after the initial fanfare wanes. While these initial trading days of IPOs can be exciting, they can be days in which a large portion of an investment can be lost.

IPOs serve a purpose, and are not inherently bad – adding more companies to the public market is vital to a thriving and growing marketplace. However, investing in an IPO may not always align with investor’s risk tolerance, or long-term goals. While there is always the chance to be an early investor in a great company, it is paramount to understand the risks associated with IPOs, and the experience of most, which have underperformed the broad market over the first 3 years after an initial offering.

We recommend investors speak with their financial advisor to ensure their investment portfolio is in alignment with their long-term goals. If you don’t have a financial advisor and would like to meet with a Fee-Only® CFP® professional at EVOadvisers, please follow this link to schedule time.

Jack O’Brien CIMA® is a Certified Investment Management Analyst educated at Chicago Booth School of Business and Virginia Tech. EVOadvisers is a fee-only financial advisor based in the Scott’s Addition area of Richmond, Virginia. EVOadvisers also has an office in Irvington, Virginia to better serve clients in the Northern Neck of Virginia. If you have any questions about financial planning and would like to talk with one of our Certified Financial Planner professionals, check us out at www.evoadvisers.com or call (804)794-1981.

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