Individual investors should tread carefully in hot but risky IPO market, experts cautionMarch 30, 2021
- The 95 IPOs that have taken place so far this year come on the heels of an active 2020, when 218 new offerings came to market.
- Generally speaking, IPOs are considered a riskier investment.
- Here are some tips if you think you'd be interested in participating.
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It looks like Main Street is poised to get in on an investment that's been largely off-limits: initial public offerings.
At least two trading platforms plan to let individual investors get early access to IPO shares, which typically are reserved for wealthier brokerage clients and institutional investors (i.e., mutual funds, hedge funds, endowments, etc.).
While the move may broaden who can participate in these offerings, experts say it won't change the risk that comes with IPOs.
"You'd want to be careful that you're not just chasing a story or 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 the investment you're making is a smart one."
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IPOs essentially involve private companies becoming publicly traded ones. That is, company shares are sold to the public. So far this year, there have been 95 new listings, according to Renaissance Capital. Last year saw 218 IPOs, marking the busiest year for new listings since 2014 when there were 274.
Before any new stock reaches the market, investment banks — which generally underwrite IPOs — sell shares that end up in the hands of select investors. Everyone else must wait until shares start trading through a market like the New York Stock Exchange or Nasdaq.
At that point, small investors might be paying more than those who got in early. The average first-day return for IPOs last year was 41.6%, according to data from IPO expert Jay Ritter, a finance professor at the University of Florida.
Personal finance company SoFi last week announced that it will let its customers in on IPOs in the near future via its plans to be an underwriter for such deals. Robinhood, the popular trading application that is planning its own IPO, also reportedly is doing the same.
SoFi said that while it won't take a commission when its customers purchase those early IPO shares, they would be charged $50 if they sell their allocation within 120 days.
"We want to educate them on IPOs, we want to make sure they have access to IPOs and then ensure they are investing over the long term in a diversified way," SoFi CEO Anthony Noto told CNBC's "Squawk Alley" last week.
SoFi's program will offer traditional IPOs, direct listings (which bypass the underwriting process) and special purpose acquisition companies, or SPACs, a company spokesperson said. SPACs essentially involve giving your money to a shell entity without knowing up-front what company it will end up investing in.
It's uncertain how many IPOs will be available through SoFi, or how many shares it would get if it is able to get in on underwriting deals.
Nevertheless, if you're interested in participating in an IPO and end up gaining access to the market, there are some things to know.
For starters, even if you are able to request shares early, it doesn't mean you'll receive the amount you requested. Generally, the more demand there is for any given IPO, the harder it is to snag shares of your own.
Conversely, if there is lukewarm interest, you're more likely to get shares. Some IPOs are already easier to access — at least for wealthier retail investors — because there is less demand from institutions. That includes real estate investment trusts and business development companies, as well as SPACs, Ritter said.
Additionally, while all IPOs generally come with risk, it's worth being selective, experts say.
"Do your due diligence," said Boneparth at Bone Fide Wealth.
That includes checking out the company's S-1 filing with the Securities and Exchange Commission to scrutinize the balance sheet and find out the potential risks of investing in the stock. (SEC Form S-1 is the initial registration form for new securities required by the SEC for public companies based in the U.S.)
Also, while many IPOs have come out of the gate strong recently, that's not always the case. And, it doesn't mean the price will keep going up.
"There's very little predictability about long-term returns based on the first day," Ritter said.
Of course, if a stock falls in its trading debut or soon after, it doesn't mean it won't go back up again. But you could be waiting a while.
For example, Facebook — which now trades around $288 — debuted in May 2012 at $38 share. By September of that year, it had dropped below $18. It took another year for it to climb back up to its initial offering price.
You also should dedicate only a small portion of your investment portfolio to IPOs.
"If you're going to look at any asset class that is arguably riskier, you want to put no more than 5% or 10% of your investable assets in it so you don't blow yourself up," Boneparth said.
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