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How to invest in a new high profile stock with less risk
No one wants to miss out on the next big thing, but you can participate with or without a lot of unnecessary risk.
Here we put aside our FOMO and learn the trick of investing from a superior risk/reward position.
The price of the stock of even the most anticipated IPOs often drops shortly after public debut - providing you with opportunities to buy the same stock at an improved risk-reward profile.
Some of the best-known IPOs fell significantly for an extended period of time before recovering - some, like Twitter never recovered. Among Facebook, Twitter, Alibaba and Google - only Google did not decline after its IPO.
In the table below you can compare the IPO price, the price after 1 month, the price after 1 year and the time it took for the stock price to recover to the IPO price. The first stock to consider is well-know: Facebook.
In this post, we will explore how to participate in the upside of a newly issued stock at a superior risk/reward ratio than generally exists on the IPO date.
No one wants to miss out on the next Google. The stock rose 1,294% in the 10 years after it went public on Aug. 19, 2004, meaning a $10,000 investment was worth $139,458.82 in 2014.
Not all IPOs behave like Google.
Some, like FB go straight down before recovering. FB opened at $38.00 on May 18, 2012. One year later it was at $26.25, on its way down to $18, before starting its recovery.
Similarly, Alibaba (Baba) tumbled nearly 30 percent in the year following the world’s largest initial public offering on September 19, 2014.
Finally, Twitter, one of the most anticipated IPOs has still not recovered off lows around 18, following its IPO at $45.00, in November 2013.
In many cases, particularly for long-term investors, buying shares on IPO day is not a prudent strategy.
How waiting to buy can improve your risk/reward position
Historical price patterns tell us there is often an opportunity to buy shares at a similar if not lower price after the market has settled. While it may be exciting to participate in the IPO of a company which creates products and services you use, it may not be the best financial move.
Not all IPOs are immediately profitable. In fact, many are not. Our snapshot of the price movements following the IPO date of several high-profile companies highlights the opportunities investors had to purchase at a better- than-IPO price.
In deciding the best time to enter the market it is critical to consider your personal risk tolerance - how much of a loss or volatility in price can you experience before selling on emotion?
In this case, Would you be able to tolerate a loss of $42 to $18 in order to participate in the upside? Would you sell when it approached your purchase price, only to miss out on the upside? The price of Facebook (FB) stock remained lower than its IPO price for 16 months. there was an opportunity to purchase at $30 just one month after the IPO, and the opportunity to purchase between $26 and the IPO price of $42 for 3 months in 2013. The downside risk was reduced in either case. What if the stock had gone straight up? You could have purchased at $58 in May 2014 and participate in increase to $118 by May 2016. Would you be willing to give up the $16 between the IPO of $42 and the $58 price two (2) years later to not experience the price drop? Your personal answers to these questions, is what "risk tolerance" measures seeks to capture.
When Snap (formerly known as Snapchat) filed for an initial public offering (IPO) of its stock, on the announcement - months before the IPO, and with no knowledge as to the financial health or business plan of the company, people started asking to buy the stock.
The lament, 'I'm not missing out this time' reflects a misconception as to the profitability and importance of buying a stock on its initial public offering (IPO) date.
Are you planning to purchase shares of a social media or technology IPO? If so, consider whether a more opportune risk/reward ratio will present if you wait until after the IPO to purchase shares.
In a majority of cases, even Facebook (FB), investors have had the opportunity to buy shares at a price below or at the IPO price with less downside and less market risk by waiting.
This retired school teacher, like many other retail investors, believed FB would "make her rich" and withdrew funds from her retirement accounts to purchase shares on the IPO date. Her investment was based on feeling "a personal connection to Facebook" and not on an analysis of the company's business and financial prospects.
Unfortunately, Facebook suffered a steep price decline - from its IPO price of $38, it fell to $17.58 (9/4/2012) before recovering to trade at, and then above the IPO price.
The majority of retail investors do not have the risk tolerance (stomach) to experience a loss of ~50% over a sustained period of time and keep their position. As a result, research shows they often sell near the low and miss the opportunity to participate in any recovery and upside.
These same investors often put their retirement and other financial goals at risk by using funds earmarked for these purposes to purchase what they believe will be "the big one."
It is not necessary to buy stock on the IPO date to participate in the upside of a high-profile stock. In fact, with a bit of patience, it is possible to significantly improve the risk/reward ratio and increase the probability of profitable investment.
How can waiting be a smart investment move?
Many familiar names trade at prices far lower than their IPO price. Let's consider a few well-known names:
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Twitter is down about 30% from its IPO price
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Etsy is down 56%
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Zynga is down 75%
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Groupon is down 85%
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In December 2014 Lending Club (LC) went public at $15. In December 2016, it closed at $5.15.
Even IPOs that are successful, like Facebook, often offer investors the opportunity for significant upside with reduced risk.
The table below shows the IPO price, the price after one (1) month of trading, the low price and recovery to IPO price.
Don't let FOMO on an IPO threaten the achievement of your financial goals.
Two key considerations when investing: 1. your personal financial position and source of funds to invest in the IPO; and 2. historical post-IPO stock prices.
Put the Purchase in Perspective
What is the probability this one stock will fund your retirement or other long-term goals? Will there be an opportunity to participate in the upside if you do not purchase the IPO? Will you be able to tolerate the volatility and price drop that may occur, and to not sell your shares at a low only to have them trade back through your initial purchase price?
Consider your personal financial situation
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Might you need this money in the near-term? If you do not have an emergency fund or liquid savings account balance or have high-interest debt you may need this money before your trade is “right” or profitable.
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Are you invested in a core portfolio structured to meet your financial goals?
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How much money can you lose on this trade without jeopardizing your financial health?
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What is your objective (take profit level) and at what price will you stop a loss?
STOCK PRICES OF POPULAR INITIAL PUBLIC OFFERINGS (IPO) OVER TIME
FACEBOOK (FB)
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