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Why Investors Should Look Beyond the IPO Hype
What investor doesn’t dream of getting in early on a stock that’s clearly destined for greatness?
Plenty of people are wistful about missing Apple’s (AAPL) initial public offering back in 1984 or Facebook (FB) in 2012.
Those are obvious big names. But what about Karuna Therapeutics (KRTX), a small-cap biotech that went public in June 2019, priced at $16 per share? It’s now trading around $100, a gain of about 525%. A stock like that is little known and didn’t go public with all the attendant hoopla of a big tech company.
In fact, two of 2019’s most prominent IPOs, rideshare companies Uber Technologies (UBER) and Lyft (LYFT) are down 17% and 34%, respectively, since their pricing on capital markets.
To be fair, it’s not uncommon for a stock to tank after its IPO, only to rally back and become a market leader. That happened with Facebook. The stock headed south immediately after its public debut. It languished for a year before beginning a strong uptrend. It was recently trading near $222 per share, a gain of 484% from its IPO.
Newly public companies often outperform the broader domestic market. There are several reasons for that. These companies often have new products or services that are in high demand. This means sales and earnings may be poised for quick growth.
Some IPOs, particularly in industries such as biotech, are positioned for an acquisition, which can result in a big payday for investors. In addition, managers of newly public companies are generally motivated to grow the company fast, as they will also be financially rewarded.
The Renaissance IPO exchange-traded fund (IPO) tracks the largest 80% of newly public companies. According to the fund literature, “sizable IPOs are added on a fast-entry basis, and the rest are added during scheduled quarterly reviews. Companies are removed two years after their initial trade date, when they become seasoned equities.”
Year-to-date, the Renaissance IPO is outperforming the S&P 500 index. However, that’s not an especially meaningful comparison, as the IPO index carves out a subset of domestic stocks with very particular characteristics. At times the S&P 500 outperforms; at other times the leader is a basket of newly public companies.
Many analysts are expecting 2020 to be a strong year for IPOs, with the first half of the year bringing more deals, as companies try to avoid potentially rocky markets around election season.
A couple of the bigger IPOs are Reynolds Consumer Products (REYN), which went public on the Nasdaq on Jan. 30, and PPD (PPD), which debuted Feb. 6.
Reynolds is familiar to consumers as the maker of its eponymous aluminum wrap, as well as its Hefty trash bags and other food storage products. The company’s brand portfolio also contains a number of other kitchen and household products.
The company plans to offer 47.2 million shares, priced somewhere between $25 and $28 apiece. That could mean a $1.3 billion IPO if all goes according to plan. REYN is selling for about $30 per share.
PPD provides contract research to biotech firms. It was previously a public company, but in 2011 was bought out by a private equity firm. The company hoped to offer 60 million shares priced between $24 and $27 each, for a total IPO value of around $1.5 billion. PPD also is trading at about $30 per share.
For a better-known consumer-facing brand, there’s mattress maker Casper Sleep (CSPR), which went public Feb. 6. However, a well-known name doesn’t necessarily equate to bigger deal size. Casper had expected to sell 8.3 million shares at a range between $17 and $19. Under that scenario, the company could have a $150 million IPO. Instead, shares were offered (and are hovering) at about $12 per share.
When buying shares of a new IPO, investors are wise to use some caution. As the trading pattern of Facebook shows, it’s typically not necessary to get in at the very beginning to enjoy healthy returns. In addition, it’s a mistake to bet on a single stock, or small group of single stocks, as a way of juicing up return for a goal such as retirement.
Instead, consider any single-stock purchase as a way of taking a flyer with some “fun money.” If it’s profitable, great. If not, the losses won’t represent a setback, and could even be offset against capital gains from better performers in a taxable account.
