Investing 101

3 Mistakes Investors Make When It Comes to IPOs

Over the many decades I’ve been an investor, I’ve seen some pretty amazing things.

One of them was the dot-com initial public offering (IPO) craze that happened in the late 1990s.

The height of the mania was from 1999 to 2000. During that time, investors could throw money at almost any IPO and get outrageous returns.

At the mania’s peak, the average first-day return was an incredible 65%. I remember those days well.

The euphoria that the market and investors experienced didn’t last long. It all came to a quick end in early 2000.

Fast-forward two decades, and the IPO market is still an exciting place to invest.

As you can see in the chart below, 2021 has been a record year for IPOs.

Annual Initial Public Offerings

Today, there are plenty of exciting companies going public. But there’s a right way and a wrong way to invest in them.

Here are three mistakes to watch out for.

No. 1: Overpaying

Overpaying for a company’s IPO is a common mistake that many investors make. Investment bankers often hype IPOs and quote overly high valuations for shares. This frequently leads investors to overpay.

But you shouldn’t treat a company’s IPO valuation differently from that of a company that’s already listed on an exchange.

For example, you should be looking at how the company’s business is doing, whether it’s profitable, and whether it’s growing revenues and earnings.

Many investors are attracted to IPOs because they think they’ll make quick profits. But that way of thinking is for speculators.

Many IPO shares will retreat after the initial euphoria of the offering has passed.

You should always treat an IPO investment as a long-term play – just like you would treat any regular stock.

Ask yourself whether this company is worth investing in at this price and what its shares are going to be worth in five or 10 years.

No. 2: Being Underinformed

Another mistake that investors make when investing in IPOs is not doing enough research. Often, the only information available is in a company’s prospectus.

However, investors can glean useful information about the company and its future prospects by looking at the company’s website. The more information you can find, the better.

I’ve even called the investor relations departments of companies that I’m interested in. If you’re persistent, you can often get information not available anywhere else.

No. 3: Miscalculating the Market

Finally, pay attention to general market sentiment. Whenever markets are moving toward euphoria, plenty of companies issue IPOs to generate capital.

However, you need to be careful. Those conditions can sometimes foretell a coming market correction. Just look at how many companies have already gone public this year.

I’m not suggesting that a market correction is imminent. Interest rates are low, and there’s a lot of capital flowing into the market.

But the bottom line is this: Always look beyond an IPO’s initial listing gains. Think long term, and do your due diligence.

Don’t be a speculator and buy shares on the first day. You’ll likely overpay if you do.

Good investing,

Dave

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