Individual investors should be cautious in a hot but risky IPO market, experts warn
Monitors display Bumble signage during the company’s initial public offering in front of the Nasdaq MarketSite in New York on February 11th.
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It looks like Main Street is ready to make an investment that was largely off-limits: IPOs.
At least two trading platforms plan to provide individual investors with early access to IPO stocks, which are typically reserved for wealthier brokerage clients and institutional investors (i.e. mutual funds, hedge funds, foundations, etc.).
While the move may expand who can participate in these offerings, experts say it won’t change the risk associated with going public.
“You should be careful not to just chase one story or one hype,” said certified financial planner Douglas Boneparth, president of Bone Fide Wealth in New York. “Don’t let excitement get in the way of making sure your investment is wise.”
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When going public, private companies essentially become listed companies. That means company shares are sold to the public. There have been 95 new listings so far this year, according to Renaissance Capital. There were 218 IPOs last year. This has been the busiest year for new listings since 2014 when there were 274.
Before new stocks hit the market, investment banks, who typically go public, sell stocks that get into the hands of select investors. Everyone else has to wait for the stock to trade on a market like the New York Stock Exchange or Nasdaq.
At this point, retail investors may be paying more than those who got in early. According to IPO expert Jay Ritter, a finance professor at the University of Florida, the average first-day return for IPOs was 41.6% last year.
Personal finance firm SoFi announced last week that it will be getting its clients involved in initial public offerings in the near future as it plans to become an underwriter on such deals. Robinhood, the popular trading application planning its own IPO, is reportedly doing the same.
SoFi said that while it takes no commission for its clients to buy these early IPO stocks, they will be charged $ 50 if they sell their allocation within 120 days.
“We want to let them know about IPOs, make sure they have access to IPOs, and then make sure they invest long-term and diversified,” SoFi CEO Anthony Noto told CNBC’s Squawk Alley last week.
The SoFi program offers traditional IPOs, direct listings (which bypass the subscription process), and SPACs (Special Purpose Acquisition Companies), according to a company spokesperson. SPACs are essentially about giving your money to a Shell company without first knowing which company it will ultimately invest in.
You should be careful not to just chase one story or one hype.
President of Bone Fide Wealth
It is uncertain how many IPOs will be available through SoFi, or how many shares it would receive if it were able to complete subscription deals.
However, if you want to take part in an IPO and end up getting access to the market, there are a few things to consider.
Even if you can request shares early, that doesn’t mean you will get the amount you requested. In general, the more demand there is for a particular IPO, the more difficult it is to acquire your own shares.
Conversely, if the interest is lukewarm, you are more likely to receive shares. Some initial public offerings are already more accessible – at least for wealthier private investors – as there is less demand from institutions. These include real estate investment trusts and business development firms, as well as SPACs, Ritter said.
While all IPOs generally come with a risk, experts say it pays to be selective.
“Do your due diligence,” said Boneparth of Bone Fide Wealth.
This includes reviewing the company’s S-1 filing with the Securities and Exchange Commission to review its balance sheet and determine the potential risks of investing in the stock. (The SEC Form S-1 is the initial registration form for new securities required by the SEC for U.S.-based public corporations.)
Even if many IPOs have gotten out of hand recently, this is not always the case. And that doesn’t mean the price will continue to rise.
“Long-term returns are hardly predictable on the first day,” said Ritter.
Of course, if a stock falls on its trading debut or shortly thereafter, that doesn’t mean it won’t go back up. But you could wait a while.
For example, Facebook – which is now trading around $ 288 – debuted at $ 38 in May 2012. By September of that year it had fallen below $ 18. It took another year before the original offer price was reached again.
You should also use only a small portion of your investment portfolio for going public.
“When you look at an asset class that arguably riskier, you don’t want to invest more than 5% or 10% of your investable assets in it so you don’t blow yourself up,” said Boneparth.