“If only I’d gotten in early on Amazon twenty years ago …”
It’s easy to slip into this kind of thinking when you read about the biggest companies in the world achieving a trillion-dollar valuation. Once upon a time, you could have bought that stock for peanuts, and today you’d be sitting on a fortune!
That’s why some folks clamor for a seat on the hype train when companies like Uber and Lyft announce their IPOs. These investors are afraid of missing out on another golden ticket.
But as we discuss on today’s episode, investing in an IPO isn’t as easy you might think. And the return on investment often isn’t as great as the hype train would have you believe.
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What is an IPO?
IPO stands for “initial public offering.” It’s the process by which a private company becomes public by selling shares of itself for the first time to public investors. Typically, founders decide to “go public” once their company has established a track record of revenue and potential for more growth. Selling shares gives the company an infusion of capital that it can then use for a variety of purposes.
Private vs. Public.
The trade-off for that big influx of cash – and in some cases, major hype and free publicity – is that public companies are now subject to regulation by the Securities and Exchange Commission and major scrutiny from Wall Street. That means expensive accounting procedures, strict operational rules, and market volatility affecting the company’s value.
Another issue is control. Publicly traded companies answer to shareholders and a board of directors. If the board isn’t happy with how the company is performing, they can vote to fire whomever is running the company, even if that person is one of the original founders! That’s exactly what happened to Steve Jobs when Apple went public and then struggled to keep pace with Microsoft during the early days of the personal computer.
On the other hand, what do Cargill, Koch Industries, Mars, Publix Super Markets, Staples, Menards, and Kansas City’s own Hallmark have in common? They’re all companies that, so far, have decided to remain private. Many of the engineering firms we work with in Kansas City are private companies as well. And you probably shop at private “mom and pop” businesses whenever you walk down Main Street in your hometown: coffee shops, clothing stores, restaurants ... and your friendly local financial advisory firm!
So, while going public does carry with it a certain prestige, there are still companies of all shapes and sizes that stay private and thrive.
The cost of FOMO.
I think a big reason that the media and the general public get so worked up about IPOs is that they feed into our “fear of missing out” (FOMO). The idea of “getting in early” on the next Facebook, Amazon, or Apple sounds like an easy way to instant riches. Folks think, “If I don’t call up my advisor and buy some Uber while it’s cheap, I’ll regret it!”
Except that’s not how most IPOs work.
According to the University of Florida’s Professor Jay Ritter, the average first-day price increase when a company goes public is, on average, 18%. So if you were one of the select investors who were able to get the stock at the “IPO price,” you might experience an average gain of 18% the first day. However, a key point to consider, is that after that 18% bump, most IPOs underperform the market average over the long-term, according to Professor Ritter.
There are, of course, some noteworthy exceptions. Amazon’s IPO in the 1990s was at $18 per share. It’s around $1,800 today.
Don’t chase “unicorns.”
But for every Amazon, there’s a Blue Apron.
The popular online meal-delivery service was another hyped IPO. Their shares opened at about $10 per share when they went public in 2017. By mid-June 2019, the shares had dropped to less than $1 per share, before the company announced a 15-to-1 “reverse split.”
Action camera maker GoPro’s IPO went from around $50 per share all the way up to $100. Now they’re trading around $6 per share.
Groupon’s IPO was around $10, and today they’re trading around $4 per share.
And currently, Uber is struggling to maintain its IPO price of $45, while Lyft is down 30%
. All of these companies were privately-held, Silicon Valley darlings valued in the billions on the day of their IPOs – so-called “unicorns.” The media hyped up each one as “the next Amazon, the next Facebook.” They weren’t.
Whenever I read about the next big unicorn IPO, I think back to the early 2000s, when some investors stampeded to invest in any company with “dot com” at the end of its name. The lesson from that era, and from the current wave of IPOs, is that there’s just no such thing as a sure thing. I wouldn’t call investing in IPOs gambling … But it’s really not all that far off. Can you afford to take that kind of chance with your nest egg?
I know that chasing the next unicorn sounds more exciting than making your monthly automatic deposits into investment and retirement accounts. But the data shows that unless you create a company like Amazon, go public, and hold your baby’s shares for decades, you’re probably better off following a disciplined, diversified investment strategy. That’s exactly our objective for our clients here at Keen Wealth.
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Bill Keen is a CHARTERED RETIREMENT PLANNING COUNSELOR℠ and independent financial advisor with more than 25 years of industry experience. As the founder and CEO of Keen Wealth Advisors, a registered investment advisory firm, he specializes in providing personalized retirement planning designed to help people thrive before and during their retirement years. With a passion for educating others, Bill regularly blogs about retirement planning, hosts the podcast Keen on Retirement, and has contributed to U.S. News and World Report, Reuters, Wall Street Journal’s Market Watch, Yahoo Finance, and other publications. Based in Overland Park, Kansas, Bill and his team work with clients throughout the greater Kansas City area and across the nation. To learn more, connect with him on LinkedIn or visit www.keenwealthadvisors.com.
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