Investing in IPO Stocks

Updated: Aug. 26, 2020, 11:41 a.m.

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 goes public.

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 its 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 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:

Step 1: Read the S-1

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.

Step 2: Consider the market

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.

Step 3: Review key metrics

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 a history of 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 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

The COVID-19 pandemic has dealt a setback to a number of companies aiming to go public this year, including big-name brands like Airbnb and DoorDash. The IPO market essentially ground to a halt during the lockdown period, and a market pullback like the one in March has a way of killing demand for new listings, as IPOs generally prefer bull markets.

However, with the market recovery in the spring, IPOs have come roaring back, and investors have been happy to scoop them up.

Among the recent 2020 IPOs to watch are the following:

  • Vroom (NASDAQ:VRM), an online seller of used cars, doubled in its debut on June 9. Investors are hoping it can repeat the performance of Carvana, the industry leader, with shares that have jumped more than 1,000% since the company’s 2017 IPO.
  • Shift4 Payments (NYSE:FOUR) also surged on its opening day, as the payments platform looks well positioned for the coronavirus era, and digital payments have also been a rewarding sector for investors in recent years.
  • Lemonade (NYSE:LMND), a tech-forward insurance company that uses artificial intelligence to sell renters and homeowners insurance to mostly millennials, has also attracted a lot of attention, with the stock more than doubling in its first weeks on the market. Lemonade is also unique as the world’s only certified B Corporation insurance company, meaning it is legally required to consider the impact of its decisions on all stakeholders.

And here are some other big names that could also go public:

  • DoorDash, the market leader in online food delivery, filed on February 27, 2020 to go public before pandemic lockdowns began. The company raised $400 million in June at a valuation of around $16 billion, which could pave the way for a public offering, especially as food delivery has been in high demand during the pandemic. Rivals are also quickly consolidating: Uber acquired Postmates and Grubhub sold itself to the Dutch company Just Eat Takeaway, meaning competition is likely to intensify.
  • Airbnb, the vacation rental giant valued at $35 billion before the pandemic, had been the most anticipated IPO of the year, as the company announced in 2019 that it would aim to go public in 2020. However, the coronavirus lockdowns temporarily crushed the travel industry and demand for Airbnb’s home rentals. In response to business suddenly disappearing, the company laid off 25% of its workforce and raised a new round of funding at half of its previous valuation. As stay-at-home orders have lifted, Airbnb’s business has come roaring back with demand focused on short-term rentals, rather than vacations, as travelers look to accommodate different needs during the pandemic. In June, management said it was on track to grow revenue this year and could still go public in 2020.
  • Robinhood, the app-based brokerage, may also hit the public markets in 2020. The company has disrupted the online stock brokerage industry and seen interest surge during the trading bonanza that followed the market crash. In July it raised $600 million at an $8.6 billion valuation, though it’s unclear if that will affect its plans to go public.
  • Instacart, the leader in online grocery delivery, could also go public this year, as CEO Apoorva Mehta said in September 2019 that an IPO is on the horizon. Instacart has seen a surge in interest during the pandemic, as grocery delivery has been in high demand, and the company raised $225 million at a $13.7 billion valuation in June. That could pave the way for an IPO, as management may want to capitalize on the pandemic-induced boom.

Even as the market has bounced back from the March pullback, there is still plenty of uncertainty swirling around investors today, and another selloff could cool off the IPO market.

2020 is definitely a unique time for new listings to hit the market, but the pandemic also has created special opportunities, especially for certain tech companies that can stand out during the crisis. Those that are seeing demand increase during the pandemic and need to raise cash will still aim to go public even if the market softens again.