Two weeks ago, Lyft kicked off a string of IPOs from well known and highly-valued tech companies like Uber, Airbnb, Slack, and Pinterest. We all know these companies well, and we might even use some of these services on a daily basis. Lyft created a lot of excitement that caught the attention of several clients and friends. Many of whom questioned whether they should buy into these IPOs early after watching the post-IPO price rise over the course of the trading day.
With the other big name IPOs still to come, I thought this would be a good topic to write about.
FOMO and Your Portfolio
In the growing field of study behavioral economists have coined a term to describe what we all know as FOMO. The “Hot Hand Fallacy” is a cognitive bias, which states investors often wrongly project the continuation of a recent trend. A stock goes up and investors assume it will continue moving up often creating bubbles within entire asset classes or sometimes just single stocks.
The examples of this behavioral phenomenon on investments are countless, the dot com bubble, cryptocurrency in 2017, etc. In the case of many IPOs, the initial day of trading leads to so much excitement that investors blindly rush into the new issue leading the stock price to hit unsustainable highs.
But I get it, no one wants to be the person who doesn’t own the new hot stock everyone is talking about. That can hurt a portfolio and an ego. The good thing about cognitive biases is once you are aware of them you can recognize them and curb that behavior. So here are some tips to consider if you are watching these IPOs and thinking about buying into that first day.
Patiently Chasing Unicorns
This particular lineup of “Unicorns” – wall street’s term for private companies with a value exceeding the billion-dollar threshold, is particularly intriguing. On the one hand, we all know these companies well, so well one of them became a new verb. However, on the other hand, many of these companies are generating massive losses and trying to disrupt well-established industries.
During the pre-IPO road show, these companies are explaining their growth strategy and path to profitability. Once these companies are public, they will have a stated strategy and they will need to report on all metrics that are related to that path to profitability. Those early public disclosures and earnings calls will provide great insight into the companies ability to execute the plan. Patiently waiting for the early reports can allow investors to better understand the probabilities of success for these unicorns. While also understanding the potential risk down the path to profitability.
Lock Up Periods
One of the main reasons companies go public is to allow early investors the opportunity to exit their investment. The IPO lock-up period ending can give savvy investors an entry point after the excitement and emotions of the IPO have worn off a little, and the early investors begin to cash out.
An IPO lock-up period is a contractual restriction preventing insiders who acquired the shares of a company’s stock before it went public from selling the stock for a period of time. The period of time varies, but it is generally 100 days after the IPO. That 100-day lock-up can lead to a selloff, which can provide an excellent entry point for new investors. Therefore, I recommend waiting until the IPO lock-up is over before deciding to invest. In addition to the potential of buying at a lower price during the temporary sell-off, you will have had 100 days to read early company reports and evaluate the strategy.
My Approach to IPOs
My advice is to stay disciplined and ignore FOMO. Watch the stock in the days and weeks following the IPO. Do your homework, read the reports, and listen to the analyst calls. If you still like the stock at or around that 100-day mark, go for it and invest.
When you do decide to own the stock in question, here are two things you should do. First, these stocks will likely remain volatile for a long period of time. Even if they settle into a regular trading range, they will be reactive to any news, good or bad. Due to that volatility, I recommend purchasing with a limit order. A limit order is a way of placing a trade only at the price are willing to pay. Second, if possible I would buy the shares in a retirement account (assuming the IPO is a suitable investment). If you have done your homework and you are correct, you will protect your gains from taxes as it supercharges your retirement. Additionally, if the stock does well for a period less than a year but news starts sending it down, you avoid paying short-term capital gains (which are the same as your normal income). For someone with an income over six figures, that would cause you to give up 24%-37% of profits.
I hope you found this blog to be interesting and hopefully you picked up some knowledge for office water cooler talk when the next unicorn IPOs. If you want to invest in the disciplined manner described above but don’t know how or where to begin, I would be happy to chat and explain any parts you have questions about. If you liked this and have other personal finance questions you would like to learn about, I would be happy to write about that next month. You can email me at email@example.com. Thanks for reading!