Should You Invest in IPOs?
Posted on July 17, 2017 by Miranda Marquit

In the last few years, we’ve seen interest in IPOs. A lot of people like to think that they could invest in IPOs, getting in when a company first releases shares of stock to the public. The hope is to get a good deal, and then ride the rise of the price.

However, before you decide to invest in IPOs as an investing strategy, it’s important to take a step back. Some recent high-profile IPOs, like Snapchat, haven’t done as well as expected.

While it can make sense to invest in IPOs in some cases, it’s vital that you pay close attention to the situation. Take the time to research whether or not an IPO makes sense in your portfolio.

Risks of Investing in IPOs

One of the biggest risks you take when you invest in IPOs is the fact that the company might not do as well as expected. There is often a spike in the price of the stock during the initial period. After things settle down, though, so does the price.

Yes, if the company is solid it can head higher down the road, even after a drop. But there’s a chance that you might end up with a loser. Until you see a couple quarters of performance, you might not be able to adequately evaluate whether or not a company is truly a good deal.

Another problem with investing in an IPO is that you might not be out of the lock-up period. In many cases, a company offers stock options to its employees, investors, and other insiders. However, these shareholders aren’t usually allowed to sell their stock until a set amount of time has passed. This lock-up period might not end until a couple months after the IPO is over.

Once the lock-up period ends, there might be an influx of shares to the market. That means that can rise beyond demand, driving the stock price down. If you buy during the IPO, you run the risk of buying high, and then seeing the price drop when the lock-up period ends. Some investors try to find out when the lock-up period will end and instead wait for that point to invest in the stock.

When to Invest in IPOs

If the company is solid, though, it doesn’t matter if the price drops a few months after the end of the IPO. After all, a good company will recover from its stock drop and become stronger over time.

As a long-term investor, it’s more important to evaluate the long-term fundamentals. You can invest in IPOs of companies you think will do well in the long term. Buy now, while the price is relatively low, and ride out the setbacks that might come in the weeks and months right after the IPO.

Investing in an IPO shouldn’t be that much different than investing in other companies. Some things to keep in mind include:

  • Long-term growth potential: Consider whether or not there is long-term growth potential. If you plan to add the IPO to your portfolio for the long haul, it makes sense to ensure that you think it will have success over time, coming through market events and overcoming initial problems.
  • Fits in with your goals: Make sure that the stock fits in your portfolio. Will it help you accomplish your goals? Does it fit your asset allocation? Does it complement what else is in your portfolio? Does it add diversity in an area you’re missing? Don’t invest in IPOs that won’t help you further your goals.

Don’t just invest in IPOs because you think it’s a cool thing to do, or because you want to impress people because you got in early. Even bargain hunting isn’t the best reason to buy an IPO. Explore your reasons for wanting to invest in the IPO.

Bottom Line

As with any investment decision, you need to make the decision based the best available data. Carefully evaluate the company to see if it is likely to have staying power and growth potential. On top of that, make sure it fits your portfolio goals. It can be the best deal in the world, but if it isn’t right for your portfolio, there’s no reason to get it.

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Written by Miranda Marquit

Miranda is a financial journalist. She specializes in writing about beginning investing, long-term financial planning, and how to get your money to work for you -- allowing you to enjoy your preferred lifestyle.

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