Why I Don't Invest In IPOs

IPOs (initial public offerings) are when a company first sells its shares to the public. Here, the goal of the company is to sell its shares in order to raise capital or present an exit opportunity. While some IPOs tend to be interesting, I am personally not a fan of investing in companies whose stock has just hit the market; the reason for this is that it is in the company’s interest for you to pay the highest amount, and that odds are you won’t “win” the trade.

Stocks have this zero-sum aspect when you are trading. If you take a simplified look at it, when a trade occurs, one party wins and the other party loses. If the price of the stock goes up, then the buyer would in a way win the trade, and if the price of the stock goes down, the seller would win. Now, in reality, it is more complex than that due to investors or traders having different motivations or strategies, or sellers could be trying to deliberately take a loss (for something like tax loss harvesting). Generally, if you are taking a position, either you or the person you traded with will end up better off by profiting or avoiding loss.

When a company IPOs, the people who would be on the other side of the trade from you are either the company, or earlier investors (those who invested prior to the stock opening on the market) in the company. Both of these parties are interested in getting the highest amount possible for the shares they sell. For a company in an IPO setting, they are trying to sell each share for as much as possible while maintaining high demand (a lack of demand is a negative indicator about the desirability of the company). They will typically do this when there is a lot of hype around their company, and they can easily sell the idea of them being a profitable investment. It is in their interest to maximize the price, so they make the most money. In this case, if you were buying from the company, your interests are directly in odds with them. Seeing as they hold the power over the supply and price, and based off of their motivations, the odds are that you are going to be paying more than the intrinsic value for the share. This means that it is likely that you are going to lose the trade. For earlier investors, their goal is also to make as much as possible and typically exit their investments. These investors will then sell shares when the company opens on the exchange, typically at a premium to what they paid for it. In this case, if you buy as the stock opens, you would be paying above the intrinsic value (company price + premium added). In this case, you would also lose the trade. In both cases, odds are that you are going to be paying above the intrinsic value for the company. Any trade where you pay above the intrinsic value is one you are almost always going to lose. Here, the search for a greater fool should start by looking in the mirror.

This is not a good situation for a retail investor to be in. Unless they have good reason to believe that the stock price will not dip and will just keep growing from the initial price, they are better off waiting until the market cools off and they can buy shares at a better price, preferably one that is below the intrinsic value. If you take a general look at stocks after they IPO, you tend to see a pop in the share price, and then they tend to cool off and dip to a lower level. The only stock I can think of off the top of my head that has not followed this trend is Microsoft. The rarity of winning a trade of an IPO from the start, and the fact that your interests are at odds with the company and early investors, is one of the fundamental reasons that I believe IPOs are overvalued and why I avoid them.