Seven Common IPO Investing Mistakes

Avoid These Seven Common Pitfalls Investors Make in the IPO Market

Initial Public Offerings (IPOs) can be exciting opportunities for investors, but they also come with unique challenges. For those new to the world of IPOs, several common mistakes can hinder success. Let’s examine and avoid these pitfalls.

1. Falling for the Hype
   Many investors get caught up in the excitement surrounding a high-profile IPO. Media coverage, social media buzz, and fear of missing out (FOMO) can lead to impulsive decisions. Newcomers are often dazzled by an IPO’s first-day pop, without realizing that only large funds are getting in at the offer price.
   
   Solution: Focus on the fundamentals. Research the company’s financial health, market position, and growth prospects. Don’t let hype overshadow due diligence, and don’t feel compelled to buy shares on the first day of trading.
   
   

2. Ignoring the Lock-Up Period
   After an IPO, company insiders are typically restricted from selling their shares for a set period, usually 180 days. When this “lock-up period” ends, a flood of new shares can enter the market, potentially putting downward pressure on the stock price during the days, weeks, or even months afterward.
   
   Solution: Identify the lock-up expiration date, and be careful about buying stock before those shares are released, especially for high-flying IPOs. However, be aware that other factors can play a bigger role, be it the stock’s momentum or a surprise earnings release. Additionally, know that the lock-up date is no secret to smart investors, and that the market can interpret a lack of insider selling as a buy signal.
   
   

3. Misunderstanding Valuation
   IPO pricing can be complex, and new investors often struggle to determine if a newly public company is overvalued or undervalued.
   
   Solution: Compare the company’s valuation metrics to those of similar public companies. Calculate the post-IPO market capitalization and enterprise value (EV), making sure to include the effect of dilutive stock options and stock awards. Popular valuation ratios include EV to sales, EV to EBITDA, and price to earnings (P/E). Consider factors like revenue growth, profitability, and market opportunity when assessing value. Fast-growing companies are often valued based on the estimated financials in the year ahead.
   
   

4. Neglecting Post-IPO Performance
   Some investors fixate on the initial pop (or drop) following the IPO, neglecting to monitor the stock’s longer-term performance.
   
   Solution: Develop a clear investment thesis and timeline. Follow your favorite New Stocks during the months and years after the IPO, looking for an entry point. It’s not uncommon to find the best buying opportunity one to three months after the IPO, when the initial hype has faded, or after the lock-up has expired. It is also important  to have a well-defined exit strategy. While investors with a long time horizon may decide to hold the stock through volatility, limit orders are an effective way to control risk.
   
   

5. Under-allocating to New Stocks
   Many investor portfolios consist of companies that have traded for decades, and under-allocate to New Stocks. Other investors get in and out of recent IPOs only on a short-term basis.
   
   Solution: Consider allocating a slice of your portfolio to New Stocks, an asset class that adds diversification and innovative technologies. If you sell down some portion of your New Stocks, try to replace them with other recent listings.
   
   

6. Overlooking the Quiet Period
   The quiet period typically extends 25 days post-IPO. Its end signals the start of Wall Street research coverage, potentially impacting stock price.
   
   Solution: Anticipate analyst sentiment. The banks issuing this research are generally the same underwriters that managed the IPO. For that reason, Street research is almost always positive, and while this is a well-known fact, a slew of ‘Buy’ ratings with some new compelling analysis can breathe new life into a stock. In rare cases, if a stock has soared to unsustainable levels, or if the fundamental outlook has somehow materially worsened since the IPO, banks may issue a ‘Hold’ rating.
   
   

7. Only Focusing on the Big-Name IPOs
   Investors often pay attention to the high-profile IPOs that dominate the headlines, however the lesser-known companies can often be the biggest winners.
   
   Solution: Consider all New Stocks, and not just the ones you see blasted in the news. Over 90% of IPOs are complete unknowns to the general public. Use the IPO Pro MUSCLE Method to quickly evaluate multiple companies on the IPO calendar.