Whenever a pretty young thing comes on the scene, it’s bound to turn heads. On Wall Street, those PYTs are called IPOs.
You’ve probably heard some buzz about the latest: Snap Inc., parent company of camera and messaging app Snapchat, started trading on the NYSE under the ticker SNAP on March 2.
An initial public offering is when a private company sells shares to the public on the stock market for the first time. It’s one way companies can raise money to expand the business. Company filings showed Snap expected to sell 200 million shares at $14 to $16 a pop—raising up to $3.2 billion. Yep, with a B. (Update: Snap’s IPO was eventually priced at $17 a share. Shares jumped nearly 50 percent in the first hours of trading.)
With lots of math, projections and help from underwriters. Before launching an IPO, a company works with investment banks (the underwriters) to determine its value based on historic and projected revenue, profits, costs and other factors. Then they determine how many shares to sell—and how many the company’s board members should keep.
The underwriters also estimate a fair value for those initial shares, but public demand plays a big role. High demand drives high prices; low demand means low prices—and possibly a delay in going public.
Brazenly. Popular IPOs are riskier than standard stocks—and, of course, don’t provide broad diversification like investing in funds—because they’re often issued by young companies with green management. Potential investors must be able to handle the risks.
If that’s cool, then you can invest once the company goes public through your broker, like with any other stock. But don’t expect to nab an IPO at its opening price, which is generally reserved for the company’s management, employees, friends and families, as well as for bulk buyers such as investment banks and hedge funds.
That said, it’s not impossible to secure initial IPO prices. The app Loyal3 announces when it’s participating in an IPO and, once the price is set, gives you two hours to confirm how much you want to invest with a $100 minimum. Similarly, online broker Motif Investing allow early access via JP Morgan with a $250 minimum. That said, the stock actually opened on the New York Stock Exchange (meaning for regular investors) at $24 a share, well above the $17 IPO price.
Your call. Like with any other investment, you have to decide whether it is worth the price and fits your investing strategy. The trouble with IPOs is that you’re not going to find much historical data and research. Plus, those early trading days are bound to endure some big price swings.
For example, when Chinese e-commerce firm Alibaba Group hit the market in September 2014, it opened at $92.70 a share—36 percent above its IPO share price of $68—and bounced between $90 and $100 throughout its first trading day. Within its first year, the price dropped as low as $58. (The stock has since rebounded, closing around $104 on February 27.)
Before that, Facebook—Snap’s main competitor (oh, hi, Instagram stories)—made its market debut in May 2012. The share price ranged between $38 and $45 on day one, but dropped as low as $18 that August. (The social media giant has proven a better bet for longer-term investors: It closed above $136 on February 27.)
It’s probably best to give a hot IPO time to cool off. While you won’t get in on the ground floor, you’ll likely miss the early peak prices driven mainly by excited chatter rather than performance. Once the frenzy subsides, you can see where the price settles and make an informed decision about whether it makes sense to add to your portfolio.
It’s worth noting that chasing any hot stock or trying to time a particular stock’s rise or fall is a risky proposition (and a potentially costly one). Advisors generally agree that the better approach is to invest for the long term with a diversified portfolio of stocks and bonds, and to resist getting caught up in the hype over specific stocks.
This story was updated on March 2.