Investing

Curious About IPOs? Experts Outline the Benefits—and Risks

Sam Becker
Twenty20

Though Uber, Airbnb, and Pinterest are well-established companies with millions of users and customers, most people haven't been able to invest in them until this year.

That's because these companies—along with other high-profile firms like Slack, Lyft, and Beyond Meat—only filed for an initial public offering, or IPO, in 2019.

Here's a primer on IPOs and how to approach them as an investor.

What you need to know about IPOs

Here are some of the basics:

  • Investing in a company before it goes public is typically only an option for friends and family of the founders, as well as other wealthy private investors and firms.
  • A company typically goes public to raise more money by selling shares of itself to the general public.
  • Before a company goes public, it files a registration statement, usually a form called an S-1, with the SEC. Looking at an S-1 and other financial disclosures that are part of an IPO can tell you a lot about a company's performance, the risks it faces, and so on.
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What Is An IPO?

Investing in IPOs is risky

It can be easy to feel like you've missed out when a company goes public and the price of its shares skyrockets.

Beyond Meat, a company that makes plant-based meat alternatives, has so far been 2019's most incredible IPO story. Shares of Beyond Meat debuted on the stock exchange in April, trading at $25 each. At one point, the stock was trading for more than $200 per share, an increase of roughly 555%. As of noon on Monday, July 8, it was trading at $157.61 per share.

But the opposite has happened with Lyft, which IPO'd in March. Since its market debut, Lyft stock fell from around $78 per share to a low of $57 per share in May, and it was trading at $58.82 per share as of noon on Monday, July 8.

Such losses are common. A recent UBS analysis based on data from a University of Florida professor found that most investments in newly public companies lose investors money after five years. Investing for the long term in a diversified mix that tracks the market is generally a much safer bet. Even with rough periods, over the past 90 years the average annual gain for stocks is 11.4%.

What the experts say about investing in IPOs

Because of the risks associated with new stocks, most financial advisors don't recommend that their clients buy shares of a company immediately after it goes public. Unless, that is, they're experienced investors who know what they're getting themselves into and have extra money to play around with.

"What people need to understand," says Andrew Whalen, CEO of Whalen Financial in Las Vegas, is that there is an "added and unique risk to buying" IPOs. But if you are doing what the experts advise and you have money left over that you're willing to gamble, here are two things experts say you should do:

1. Do your research

If you're serious about investing in a company, it's worth your time to take a look at the S-1 form the company had to file with the government before they IPO'd as well as any other related research you can get your hands on. In other words, do your homework and you'll get a sense of whether the company seems stable.

2. Make an appropriate investment

Keep your expectations in check and your investment modest. Don't assume that the company you're investing in is going to see Beyond Meat-like growth.

"Because of the unpredictability of how an IPO might perform," says Jenifer A. Aronson, managing partner at Illinois-based financial firm Mosaic Fi, think about "appropriate sizing."

For example, if you invest $1,000 in a newly public company, and its shares lose half of their value, are you going to be able to stomach a 50% drop in your investment? That may be the most important thing for investors to consider.

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