Almost every stock on the market today was an IPO stock at one point in its history.
The initial public offering (IPO) has long been the primary vehicle for companies entering the public markets. In this process, a privately held company declares its intention to go public by filing with the U.S. Securities and Exchange Commission (SEC). Over a period of several weeks, the company then works with underwriters to sell blocks of stock to institutional investors. Then, if everything goes well, the company and its underwriters set the IPO price, and the stock begins trading publicly on an exchange, with shares becoming available to regular retail investors like you and me.
The definition of an IPO is simple: An IPO stock is one that either recently debuted or is about to. Investors use the term to refer to any stock that is near its IPO date, generally up to one year after it.
How to invest in IPOs
Retail investors can’t generally buy shares of a stock before it begins trading on an exchange. When a company is private, restrictions prevent most regular investors from accessing a company’s stock. Even in the time leading up to an IPO, a company sells only a small percentage of its public stock, and there’s often more demand than supply, making it difficult for individual investors to get their hands on a stock before opening day.
But once the stock begins actively trading, buying shares is as easy as buying shares in any public company. You just place an order with your brokerage. To see a list of recent and upcoming IPO stocks, you can visit the Nasdaq’s IPO Calendar, which includes IPOs on both the Nasdaq and the New York Stock Exchange.
That said, you should do research on the IPO stock that interests you before investing in it. Here are three important research steps to take:
Before deciding to invest in an IPO stock, it’s important to read through the company’s S-1 document, or prospectus. This document is filed with the SEC when the company decides to go public.
It contains tons of useful information that isn’t often available publicly for private companies, including financial statements, management discussion and analysis, and a description of the company, its business segments, and its history, as well as its growth opportunities and strategy.
Within the S-1 document, look for details on a company’s total addressable market, or TAM. IPO stocks tend to be at the early stage of their life cycle. They are usually start-ups looking to get more funding and take more market share from industry incumbents. Therefore, they are almost always growth stocks, and often industry disruptors.
That’s why they often explain their growth potential in terms of the total addressable market for their products or services, or how much consumers are already spending on those products and services.
When considering an investment in an IPO stock, you should also consider factors like revenue growth, profitability or profit potential, competitive advantages, and leadership, just as you would with any other stock.
Look for signs that a stock has the potential to deliver long-term growth, like high revenue growth, evident progress toward profitability (if the company isn’t already profitable), or signs of competitive advantages like barriers to entry or a disruptive innovation. To assess a company’s leadership, check out ratings and reviews on Glassdoor, as well as press coverage and interviews with leadership.
Why you should invest in IPO stocks
IPOs can be exciting for investors, offering the chance to get in on the ground floor of a stock. Since IPOs are almost always young companies and are at the beginning of their trading lives, they also have the potential to generate greater returns than any other kind of stock, especially those of more mature companies. For example, consider how much early investors made on stocks like Home Depot (NYSE:HD), Amazon (NASDAQ:AMZN), and Starbucks (NASDAQ:SBUX). Some stocks like these have even turned $1,000 into $1 million.
That said, not every IPO is a good investment. The hype around IPO stocks can distract even experienced investors from a company’s overall health -- and even promising ideas can struggle on the public markets.
While it’s true that most IPOs underperform the market, the windfall from a big winner can more than make up for several losers. Not every IPO is going to be the next Amazon, but by following the steps above, you stand a better chance of finding high-quality stocks that can last past the initial hype cycle and give you the greatest chance to beat the market.
IPOs to watch in 2020
Among the most anticipated IPO stocks of 2020 are the following:
- Casper Sleep (NYSE:CSPR), a popular online seller of mattresses and other sleep products, debuted on February 6, 2020.
- DoorDash, the market leader in online food delivery, filed on February 27, 2020 to go public.
- Airbnb, the vacation rental giant last valued at $35 billion, is probably the most anticipated IPO stock of the year. The company announced in 2019 that it would aim to go public in 2020.
- Postmates, another provider of food delivery, initially filed to go public in February 2019, but then held off after fellow unicorns (startups worth more than $1 billion) Uber (NYSE:UBER) and Lyft (NASDAQ:LYFT) had disappointing debuts, and WeWork collapsed before it even went public.
- Robinhood, the app-based brokerage, may also hit the public markets in 2020. The company has disrupted the online stock brokerage industry, but competitors have responded by also offering no-fee trading, leading to questions about Robinhood’s competitive edge.
- Instacart, the leader in online grocery delivery, could also IPO this year, as CEO Apoorva Mehta has said that an IPO is on the horizon. With competition mounting from Target (NYSE:TGT), Amazon, and Walmart (NYSE:WMT), the company may need to go public in order to continue growing.
Here are two recent IPOs that look promising:
- Pinterest (NYSE:PINS): The social media company and virtual pin board has struggled since its IPO last April, but has potential, as its user base and revenue are growing quickly, with revenue up 51% last year. Monetization rates also have a lot of room for growth, as Pinterest’s average revenue per user is still a fraction of the average of Facebook (NASDAQ:FB) or Twitter (NYSE:TWTR).
- Bill.com (NYSE:BILL): This cloud-based software provider handles financial payments and other transactions for small and medium-size businesses. Bill.com has acquired customers efficiently over its history, with much lower sales and marketing costs than other software-as-a-service (SaaS) companies, and it benefits from network effects as its algorithm improves with the expansion of its member network. In its most recent quarter, revenue jumped 50%.
While investor sentiment has shifted following the WeWork debacle, and with coronavirus concerns putting further pressure on the market, 2020 may be a challenging time for new stocks. Still, many companies at this stage in their development will still aim to go public.