I’ve participated in two IPOs as an investor, and neither outcome turned out great.
The first involved a tech spinoff from my employer at the time, so I was able to buy shares at the IPO price. This was happening just as the tech bubble at the turn of the century was starting to deflate. Lesson learned: shares of newly formed public companies can go down in value just as readily as they can rise.
Next up: Twitter (TWTR), Day One, Nov 7, 2013. I ignored the advice from the experts to let the dust settle before jumping in — not only on this particular IPO but on any IPO. I considered myself fortunate to get out two years later at break-even. Lesson learned: let the dust settle before jumping in.
Sometimes, though, the dust doesn’t settle.
E-commerce software company BigCommerce Holdings (BIGC) went public on August 5. The stock’s first trade was at $68 a share, 183% above the $24 IPO price. Today, three weeks later, BIGC notched another high before closing at $145, topping the IPO price by a factor of six.
The dream lives on!
And below, you’ll read about a potentially profitable way to pursue it.
— Bob Bogda, Editor
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By the end of the first quarter, with the stock market down 20% since the beginning of the year, companies looking to go public via an initial public offering (IPO) were surely disheartened. Plunging markets are hardly a comforting backdrop for this risky segment of the market. Buyers tend to go on strike during such times, which could lead to tepid demand for a newly public stock. First impressions matter.
As we now know, the market went on to post a heroic comeback. Since bottoming on March 23, the S&P 500 has risen a remarkable 56%. And that has provided a clear tailwind to the IPO market. According to Renaissance Capital, the year-to-date returns for IPOs are now up more than 40%. The S&P 500, in contrast, is only up a more modest 6% in that time.
We’re talking about a corner of the market that is simply booming. In March, April and May, just 13 firms went public, according to Renaissance. Over the next three months, the figure swelled to 74.
Much of the action has focused on the healthcare sector in recent months. A slew of biotechs have come public, delivering an average 34% one-day gain, according to Dealogic.
Attention is now shifting to tech. In the next few months, look for high-profile IPOs from tech unicorns such as Airbnb, Palantir, and Asana. Investor appetites are surely whetted for these tech IPOs. Online mortgage company Rocket Cos (RKT), for example, has seen its stock surge from an early August IPO priced at $18 a share all the way up to a recent $28. That’s a more than 40% gain in less than a month.
To be clear, some of the best gains in IPOs are had by investors that owned shares on the day they began trading. That means company insiders, a firm’s financial backers, and select clients at underwriting investment banks gain special access to the “one-day pop” that many new IPOs get. For the rest of us, hopes are pinned on ongoing upward momentum after shares have begun trading.
But such shares carry one clear risk factor: lock-up expirations. Key shareholders must wait a period of time (from 90 to 180 days) before selling their shares. And when they do, they often do so all at once.
The higher a stock has risen in subsequent months, the greater will be the temptation for locked-up shareholders to sell and seize their profits. In fact, you can keep an eye on recent IPOs that are approaching a lock-up date by visiting this website. Alternatively, you can download at sec.gov the S-1 of a newly public company’s stock to see the specific anticipated lock-up expiration date.
Often, the expiration of the lock-up period unleashes waves of selling that pushes shares back down to levels that once again hold appeal.
But trying to time individual stock price moves can be both tricky and time-consuming. Instead, there’s a smarter way to avoid that IPO risk, while still also capturing the longer-term upside that newly public companies often offer. I’m referring to exchange-traded funds (ETFs) that focus on the IPO market.
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For example, the Renaissance IPO ETF (IPO) has risen 45% thus far in 2020, according to Morningstar, and has provided a solid 17% annual return over the past five years.
This ETF, which charges 0.60 percent and has $66 million in assets, takes a wait-and-see approach. Shares of a new issue are bought only after a waiting period. Specifically, five business days must pass after an IPO event for larger new issues to be included in the fund, while smaller IPOs are only added to the fund during a quarterly rebalancing. Shares are then held for a two-year period. That holding period reflects the fact that newly trading firms are often eventually added to major indexes such as the S&P 500.
Investors may also want to consider another approach to the new-issues market. The First Trust US Equity Opportunities ETF (FPX) focuses on both IPOs and corporate spin-offs of existing legacy divisions of larger firms. Once able to operate on their own, these newly public companies tend to benefit from more focused and decisive management teams that have been unshackled from the parent company’s yoke.
This fund, which charges a 0.58% expense ratio and currently has $1.3 billion in assets, has delivered an equally impressive 19% annual return over the past decade, according to Morningstar. Current top 10 holdings include PayPal (PYPL), Tesla (TSLA), and Spotify (SPOT).
While I am always concerned about the near-term impact of lock-up expirations, a focus on the longer-term with these funds helps explain their robust results over time. I am partial to the First Trust fund, mostly due to its emphasis on larger companies, which may hold their ground better in challenging markets.
Action to Take: Buy the First Trust US Equity Opportunities ETF (FPX) up to $105 and sell when shares reach $130.
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