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Why You Should Wait Before Buying Into an IPO

By Motley Fool Staff - Jul 19, 2017 at 2:50PM

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Investors should wait at least six months after an IPO to buy in given the huge amount of risk for losses.

In this segment from Industry Focus, Motley Fool analysts Dylan Lewis and Michael Douglass explain some of the most important reasons why investors should wait at least six months until after its IPO to buy into a public company. Find out what you need to know about the timing of an IPO, why it's so important to have a history of quarterly reports backing a company up, how filing requirements are different for established and growth companies, and more.

A full transcript follows the video.

This video was recorded on July 14, 2017.

Dylan Lewis: My guidance for investors is, looking at tech IPOs and IPOs broadly, wait six months, I might even say a year. I think there are a couple of core reasons for this. The big one for me is, the company decides when it goes public. That's one of the most important things you have to understand about the IPO process.

Michael Douglass: Yeah. In a lot of ways, they're timing the market for themselves. They're saying, "Here's the story we want to tell. The metrics are lining up with that story. Here's a great time to go public." And keep in mind, a company is very heavily incentivized to do this. The reason you go public, the reason you take on all the extra scrutiny and reporting, is so you can unlock a bunch of cash. So why wouldn't you do that when you can unlock the most cash, because you're able to tell the best possible story? It makes a lot of sense from a business standpoint. What that means, though, is that retail investors who are hopping in early may be coming in when things look better than, maybe, long-term, they could be.

Lewis: Yeah. IPOs are capital-raising events. That's the thing you have to remember. And management is deciding when they're going to be selling these shares. You might run into situations, I think Snap (SNAP -1.44%) might be an example of this, where at the time of filing, the business metrics maybe look as good as they're going to for quite some time. So with Snap and its property Snapchat, the company's user base was beginning to show signs of decelerating growth. I think they went from 20% sequential growth in Q2 of 2016 to 4% sequential growth in Q4 of 2016. So they might have been reading the tea leaves and saying, "I don't know that things are going to get too much stronger anytime soon. We haven't really turned on the ad monetization yet. We can sell a story of promise and potential. Let's raise capital now rather than risk the core business metrics deteriorating, and then raising capital at a lower valuation down the road."

Douglass: Absolutely. I think one of the other key things to look at is that you only have so much information to look at, going backward. The S-1, maybe they'll have a couple of years of data there. But you're not really able to tell a lot of the long-term story in a way that you can about, for example, Johnson & Johnson, which has been public forever.

Lewis: Yeah, and the filing requirements are actually different if you're an emerging growth company, which is less than $1 billion in revenue over the trailing 12 months or most recent fiscal year; I forget the exact categorization there. So how close to the IPO do you have to file, and some of the information you have to file, will depend. And that is meant to make it easier for smaller companies to go public. But that also can put investors at a little bit of a disadvantage. That is something to keep in mind. I think one of the things, particularly as Foolish investors, that we want to see with companies that buying into an IPO early doesn't give you access to is understanding how management handles the scrutiny of being public. I think that's such a big part of understanding the general philosophy of a business, and also, how they're going to weather tough times and not-great business outcomes.

Dylan Lewis owns shares of JNJ. Michael Douglass owns shares of JNJ. The Motley Fool owns shares of and recommends JNJ. The Motley Fool has a disclosure policy.

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