What is an IPO in stocks, and should you invest in them in 2020?

Sep 29, 2020 05:01 AM ET
What is an IPO in stocks, and should you invest in them in 2020?

Overview

IPOs are one of the most highly-anticipated events for stock market enthusiasts and investors, especially for tech unicorns that have only scratched the surface of their enormous potential long term, tech unicorns that have transformed entire industries. 

So, what exactly is an IPO? Shorthand for initial public offering, an IPO suggests the process of offering new stocks of a company to the public. In essence, it’s the transformation of a private corporation to a publicly-traded corporation. Every stock in the stock market was once an IPO at some point.

Why would a company offer an IPO?

Of course, the primary motivator for companies becoming IPOs is for capital expansion. Whether a company is already very well-known or not, any IPO comes with significant investment from small to large players and immense brand recognition. Companies list on the stock exchange also for prestigious reasons as very, very few companies are successful enough to go public.

The parties involved in setting up an IPO

The main bodies responsible are investment banks who act as the underwriters to the IPO. The use of investment banks is the most common method for IPOs, though some cut out the middleman by directly listing themselves. The business that’s looking to go public approaches these underwriters who then create a prospectus after they’ve met all the minimum requirements. Underwriters also act as the link who pitch the shares of the IPO to private investors before the date of going public and deciding factors such as the starting price and market capitalization.

Should you invest in IPOs in 2020?

What makes IPOs a unique investment strategy is the potential for gaining ‘early access’ to a stock that has a genuine chance to outperform many other markets in the long run. Effectively, we can imagine it as buying a stock from zero many years before it’s considered a stock worth owning. This idea is one of the greatest advantages of IPOs and why they garner significant interest.

The data itself backs up many of these thoughts. As one example, we can look at the American software developer, HubSpot, as a successful IPO. The company went public on the 10th of October 2014 at $29.05 a share. Looking at the graph below, we can see the stock has been in an uptrend ever since, doubling its price almost 900%.

 

HubSpot

 

The supply and demand in the initial stage of an IPO may be very speculative and unpredictable. Furthermore, having no historical price data to determine a possible outlook doesn’t help matters. Therefore, we should consider buying new stocks as a very long-term ‘buy and hold’ strategy, which is a much simpler approach than scalping or day trading. Albeit, the strategy requires an enormous amount of patience.

Over the last few years, IPOs have been euphoric and somewhat over-hyped stock market frenzies meant to drive investors to plow more funds into their portfolios. By increasing market capitalization, companies get much-needed cash injections that will hopefully make them more profitable. However, this begs why big companies go public in the first place and what we need to know.

In reality, we may as well call underwriters marketers since they do earn commissions from ‘marketing’ IPOs. As a result, the price of new stocks tends to be higher than is the norm, which is always a debatable issue. This fact makes them typically reserved for elite investors or speculators.

While we may never know all the factors that investment bankers and the like use to determine these prices, one of the things to consider are the founders, venture capital firms, and other high net-worth investors invested in the company. We don’t know if the price is high because it’s a way out for them to cash out for others to cash in. 

The main gist is that IPOs are not what they were at least a decade ago, mainly due to their hyper valuations. While many of the companies that have gone public have demonstrated future potential, they are still technically not profitable despite tremendous yearly turnover figures. The kind of companies criticized for this trend are mainly in the sector. One doesn’t have to go far back for this example. Guardion Health Sciences has been on a steady decline since its IPO day on the 5th of April, 2019, currently trading at $0.20.

 

Guardion Health Sciences

The image above should not deter any investor thinking of IPOs. The only decision that determines whether an IPO is worth betting on is whether the fundamental data objectively makes sense. Looking at the data to find any feasible possibilities for a stock to experience runaway success takes one to ignore any hype around the IPO.

5 IPOs to look out for in 2020

It’s critical to note that some of these companies have not confirmed exact IPO dates, but speculations are rife they will soon go public. The vital aspect to note about these recommendations is they are companies in industries that will continue to have massive demand in the future. While the financial performance of each respective brand may not be spectacular, their unique selling points have brought them to be the large players they are currently.

Airbnb

Airbnb

Considered the ‘Uber’ of home rentals, Airbnb is one of the world’s leading lodging marketplaces currently valued at $35 billion, with at least 150 million users using their platform. In its 12-year history, the company has firmly proven itself as a disruptor in the home rental sector both for consumers and homeowners alike. 

 

Robinhood

Robinhood

Robinhood has grown quite substantially in a relatively short time of 7 years to being currently valued at $11.7 billion with at least 13 million users. Their commission-free stock, ETF, options and crypto trading platform has massive potential to grow even greater in the financial services space.

 

Wish

Wish

Wish has been dominating the e-commerce space for several years, bringing its valuation to $11.2 billion. At least 90 million users worldwide use Wish, making them one of the world’s fastest-growing and largest e-commerce marketplaces.

 

Instacart

Instacart

Though only operating in America and Canada (with at least 350,000 users), there is still room for worldwide adoption for Instacart to dominate the online grocery delivery market and bump up its $14 billion valuation figure.

Palantir.jpg

Palantir

Perhaps one of the lesser-known brands on this list, Palantir is a major player in big data analytics software with an impressive valuation of $15 billion. In fact, the company is so niche reports suggest the company has about 125 customers, mostly government and large commercial clients. This brand makes for a fascinating case for an IPO in a niche market like data analytics.


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