Fall is upon us, and pumpkin spice-flavored everything is rolling in like a cool breeze. Despite their ubiquity, $5 coffees have taken a backseat to IPOs this fall as investors have lined up for a chance to buy shiny, newly-minted public companies. Many companies have debuted to hungry investors ready to scoop up shares at any price. Fanfare aside -- do IPOs deserve a place in your portfolio, or are you better off just sticking to lattes this season?
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What's all the excitement for anyway?
An Initial Public Offering (IPO) is when a company chooses to sell shares on the open market so that regular investors -- such as us -- can become partial owners. IPO day is exciting, particularly because a lot of money can be made incredibly quickly. For example, newer investors may see the initial pop of recent IPO Snowflake (SNOW 2.53%) as a quick way to realize over 100% gains in a single day. Investors in IPOs may be looking for a fast return, or they may know a lot about the company and be willing to buy it at any price for the opportunity to get in early. It makes a lot of sense that investors are willing to dive in on day one if they believe they have a shot to buy the next Amazon (AMZN -1.64%). However, the short-term allure of IPOs frequently becomes a trap for retail investors, as institutional traders can heavily bid up the stock price.
IPOs are incredibly volatile
I'll say that again: IPOs are incredibly volatile. Snowflake has yielded quick returns to those who bought shares at $120 before the company hit the market, where prices immediately rocketed to $245 for Snowflake's first public trade. However, it has been a disappointment to investors who bought shares after the opening bell on IPO day. Not only is Snowflake trading around the price at which it opened, but it's also significantly below its IPO day high when it sported a $319 price tag. And the bad news may not stop there for short- to medium-term investors, as the worst is yet to come according to Snowflake's first Wall-Street analyst.
The hoopla around an IPO breeds volatility in the company's valuation, and Snowflake isn't the only recent IPO to lead by example. Lemonade (LMND -0.46%) debuted in early July with a target IPO price of $29. Lemonade also soared out the gates, gaining over 200% in its first weeks as a public company. It now goes for around $51, a more "meager" 76% return since its debut in early July.
So... are recent IPOs worth buying?
A company's status as newly public doesn't necessarily make it a good investment nor a bad one. Remember not to get swept into the hype around a company solely because it's new -- you wouldn't blindly buy stocks in general, and an IPO is no exception. Instead, there are two alternate options that you might want to consider if you're following a recent IPO. First, you could sit on the sidelines, add the company to your watchlist, and see what happens over the next few quarters. This way you can assess the financial strength of the business and see how the valuation holds up. The second option, if you really need to own a new IPO, is to make it a small portfolio position of under one percent. This way any volatility should serve as more of a buying opportunity than a punishment for investing in growth.
Ultimately, only you can determine if a recent IPO belongs in your portfolio. As with any investment, know what you're buying. IPOs are speculative in nature because of a lack of proven track record. While this may work with your investment strategy, I won't be buying fresh IPOs any time soon.
