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It is rare to turn to business news and not see an article detailing the latest craze around a debut IPO (IPO stands for initial public offering). The often-sought unicorn gets a lot of media buzz when it shoots up in its initial day—people holding the IPO rejoice and people not holding consider buying it.
Wednesday, September 22, 2021, the market saw the IPO debut of Toast, a company that offers a point of sale system for restaurants.
Investors who bought the IPO at the price of $40 saw quite the return. By the end of the day, their shares were up 56% and closed at over $60 a share.
Now think about that a moment—56%. In a single day.
That means that a $10,000 investment would have turned into $15,600. In a few hours. Talk about a hard day’s work. Here’s the fact: You can stand to make a lot of money if you pick the right IPO and watch that valuation climb like there’s no limit.
Do a quick google search and you’ll find articles suggesting returns around 900% if picking the right IPO. That kind of return is alluring to any investor and none of us is immune to the siren’s call.
You can also make a lot of money if you go to the racetrack and put your money on the horse that ends up winning. Or betting on a sports game or heading to your local casino.
But that’s the catch, isn’t it? We just don’t know. Investing in an IPO is a gamble.
Toast could have just as easily gone the route of so many IPOs who start strong with a solid valuation but get destroyed by the market. According to CNBC, “more than 60 percent of IPOs from a selection of 7,000 that debuted from 1975 until 2011 had a negative absolute return after five years.”
First day returns can be misleading.
Take the case of Oatly, creator of a plant-based dairy product marketed to baristas at coffee shops. The stock debuted on May 20 at $17 a share, soared 30% immediately, then tapered back a bit but still finished the day strong. Fast forward a few months, and the stock is now trading at around $14, below their IPO price.
When investors say, know the company, know the product, they’re absolutely right, but there’s more than that. I, personally, love Oatly and have regularly used their products and fully believed they would do well. It’s plant-based, better for the environment, and it can make some mean latte art. It looked like it was shaping up to be the next Beyond Meat—
which, if you remember, had an IPO of $25 a share, hit $234 a share within a few months, and was poised for awesomeness . . .
While it is currently trading down from that high around $95, it is still close to a 400% of a return.
Did I personally invest in Oatly? Nope. Am I glad I didn’t? Absolutely.
Here’s another example of a more detrimental stock—GoHealth, which debuted in July of 2020 at $21 a share. That stock is now trading at $5.70 a share.
Want another one? Sundial Growers—a cannabis producer from Canada. IPO in 2019 for $13 a share. Problem after problem after problem and now? 67 cents a share. Yes, you read that right, less than a dollar.
That’s a loss of 95%. Back to our $10,000 example, you’d be left with $500. And that hurts. Does it hurt as much as feeling like you lost a great opportunity? Only time will tell, but at least with the missed opportunity, you still have your original investment.
In the end, we just don’t know. That’s why its best to tend toward the safety of diversification, allowing wealth to grow while hedging one’s investments and taking full advantage of the time value of money.
Besides, with a 12% return year after year (the average return of the S&P 500), your investment will double in just six years. While that may not be as sexy as a 56% return in a single day, it will definitely help you sleep better at night.
And, maybe that’s a bit more important overall.
Does that mean never invest in an IPO? Not at all, in fact, it can certainly be a fun ride, as long as you are willing to lose whatever money you put in. And assuming you are involved early enough in the process to see those returns. Investors who got excited about Toast after the first day were in for disappointment the rest of the week—those who bought at $61 a share are now sitting on shares worth $53—still a great return for initial IPO investors, but down about 10% for those who bought after the initial craze.
Thanks for reading and happy investing.