The Ins and Outs of Investing in IPOs

You have heard the stories. A company goes public, and the first day of trading it soars by 80%. Seems like easy money.

As my colleague John Persinos recently pointed out in his story Red-Hot IPOs: Don’t Get Burned, the initial public offering (IPO) market hasn’t been this hot in years. In the first half of 2021, IPOs raised $171 billion. The average first-day gain for these IPOs was over 40%.

There’s a catch though. Few of those shares end up in the hands of retail investors.

When a company wants to go public, it will usually hire an investment bank to sell shares. These banks will offer most of the shares to institutional investors like pensions, hedge funds, or mutual funds.

The investment banks sometimes offer a small allotment to retail brokerages, but your broker will usually offer a disclaimer like this one from Fidelity: “IPO shares are limited, often with more demand than available shares. As a result, you may not always receive shares or the number of shares you request.”

So, when you see those big first-day IPO gains, rest assured that it’s difficult to be one of those investors reaping those gains.

However, it’s not impossible. Your broker may offer IPOs, but they will probably have some specific requirements, like a certain level of retail assets under management. If you qualify, you can sign up for alerts and be notified of upcoming IPOs.

Fidelity offers IPOs from Credit Suisse, Kohlberg Kravis Roberts & Co., and several other underwriters. A quick check shows that they have five IPOs upcoming in the next 10 days. I don’t recognize any of the companies, but Fidelity has also offered IPO shares this year from household names like Krispy Kreme (NSDQ: DNUT) and LegalZoom (NSDQ: LZ).

But those big first-day gains aren’t guaranteed. Last week popular meme-stock broker Robinhood (NSDQ: HOOD) stumbled a bit on its first day, falling 8.4% below the IPO price in its first trading session. And some IPOs end up being “busted”, which means they have fallen far below their initial price.

If you can’t get in at the IPO price, are those big gains still available if you purchase after the first day of trading? That approach wouldn’t have worked out very well this year. Last week CNBC ran a story that gave the details for the 2021 IPOs. So far, 49% of the 2021 IPOs are above their IPO price, with an average return of 6.7%. But that same group is down an average of 13% after the first day of trading.

Investing in IPOs can be risky. The lesson is, conduct due diligence, get in at the IPO if you can, and don’t jump in later.

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