There's a certain allure of finding the next big thing, getting in on the ground floor, and riding it to untold riches. And there are certainly those investors who feel that the best way to make this dream a reality is by putting their hard-earned cash to work in the next red-hot initial public offering (IPO). Unfortunately, the reality is usually far different, and in most cases the only people who get rich when a company goes public are the founders and early, private investors.
As a long-time investor myself, I have made it a general rule to avoid buying stocks when they make their debut on the public markets -- and there are lots of reasons why (I'll get to some of those in a minute).
That said, I am considering breaking my own rule and putting a small amount of my own money in an upcoming IPO that shows more than the average amount of promise: Snowflake.
Image source: Getty Images.
The basics
Snowflake is a cloud data management company that plans to trade its shares on the New York Stock Exchange using the ticker symbol "SNOW." The company has yet to schedule its debut, but some reports suggest that the IPO may be as early as Wednesday of next week.
A recent regulatory filing reveals that Snowflake plans to offer 28 million shares in a range of $75 to $85 per share, which would raise more than $2.7 billion for the start-up. That would value the company at nearly $24 billion at the high end of the range.
Lots of reasons to avoid IPOs
Individual investors almost never get in at the IPO (price), particularly when there's a high level of interest like there seems to be with Snowflake. That privilege is reserved for investment banks and institutional investors, which have greater access to the shares prior to their public debut. Additionally, IPOs are generally much riskier than your average investment, carrying a great deal of uncertainty due to the lack of a significant track record that accompanies these fledgling companies.
There are other potential issues. Just because a company has captured the public imagination doesn't necessarily mean it will be a good investment. Lyft and Uber were among the most highly anticipated IPOs in years when they debuted within weeks of each other in early 2019, but they have failed to live up to the hype. Since their IPOs, Lyft and Uber have declined 62% and 12%, respectively, leaving early investors holding the bag.
For every rule, there's an exception
There are several reasons I'm considering an investment in Snowflake. The first is the company's eye-popping top-line growth rate, though its track record is admittedly short.
For the fiscal year ended Jan. 31, 2020, Snowflake reported revenue of nearly $265 million, up 173% year over year. The hectic pace of growth continued into the first half of 2020, with revenue of $242 million, up 133%. It's worth noting that the revenue for first six months of this year is nearly on par with all of last year -- that's saying something. It's also important to note that the company's bottom line is still solidly in the red, as its net loss of $349 million last year worsened from a loss of $178 million during the prior year. There was improvement over the past six months, however, as Snowflake trimmed its losses to $171 million from $177 million in the prior-year period.
There's more. Just this week, Snowflake revealed the existence of a couple of high-profile backers for its public debut. Warren Buffett-helmed Berkshire Hathaway (BRK.A +0.50%) (BRK.B +0.76%) and salesforce.com (CRM 2.37%) have each agreed to invest $250 million in the company using concurrent private placements at a price equal to the final IPO price. In addition, Berkshire will also purchase an additional 4 million shares from Snowflake's former CEO in a private transaction, also paying the IPO price. This could bring the total of Buffett's investment to more than $500 million.
Image source: Getty Images.
Salesforce Ventures, the investing arm of the tech giant, has a pretty impressive track record for investing in early stage tech start-ups. The company has previously invested in Zoom Video Communications, Twilio, and DocuSign, each of which has been hugely successful since its public debut.
Warren Buffett has famously avoided IPOs, quipping in 2016, "You don't have to really worry about what's really going on in IPOs. People win lotteries every day ... " He went even further last year when he said in an interview, "In 54 years, I don't think Berkshire has ever bought a new issue."
It's important to note that it likely isn't Buffett himself who made the move, but one of his trusted money managers, Ted Weschler or Todd Combs -- regardless, it has broken more than a half-century of tradition at Berkshire Hathaway. If such highly respected investors think Snowflake is a buy, the company gets an extra boost of credibility.
Is it worth the risk?
Given the stratospheric growth rate, the strong secular tailwinds for cloud computing, and the backing of both Buffett (indirectly) and Salesforce, I might break my own rule and invest in Snowflake's IPO. While there are still plenty of reasons to sit on the sidelines, Snowflake has a few things going for it that other recent and upcoming debuts simply can't match.
I understand going in that the company is not yet profitable, and falls squarely in the high-risk, high-reward category. As such -- even if I do invest on IPO day -- it would still be with a very small amount of money, commensurate with the higher degree of risk.
