Wall Street loves initial public offerings (IPOs), seeing them as a coming-out party for stock market debutants making their big transition into public trading.
But that’s not always the case for retail investors, who often get short shrift on IPO day.
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For example, Pets.com (1) was a victim of the 2000 dot-com crash. Despite a $300 million public funding injection and a moderate $11-per-share trading price, the company filed for bankruptcy and liquidated its assets within 269 days. It sent scores of investors to the sidelines with their pockets empty.
More recently, Robinhood Markets’ [NASDAQ:HOOD] 2021 IPO saw the digital micro-trading platform’s shares fall by 8% on its first day of trading, leaving many investors empty-handed.
Retail investors tend to get shut out of the best IPOs and the best prices, and that’s by design, market mavens say.
“The problem with IPOs, especially at this scale, is that many investors have had access to the company long before it begins trading on public markets,” Nic Puckrin, a macro market analyst at Dubai-based Coin Bureau, said. “Founders, employees and early investors often acquired their stakes at valuations far below those available to retail investors. By the time the stock begins trading on the public market, regular investors are the last ones in line.”
Main Street investors take risks with IPOs
With SpaceX, Anthropic and computing darling Quantinuum all lined up for big IPOs this summer, it’s a good time for retail investors to understand the downside of buying brand new shares in a company’s stock.
These investment risks, in particular, should be factored in before opening any trading apps for a new public stock offering.
The IPO deck is stacked against small investors
Even when retail investors can technically participate, the process works against them.
“First, brokerages that offer IPO access often require a minimum account size or trading history to qualify,” Jeffrey Goldberger, a managing partner at KCSA Strategic Communications, said. “Second, demand for high-profile IPOs is enormous, so even if you apply for shares, you may receive only a partial allocation, or none at all.
“Third, and most importantly, by the time the stock opens for trading on the public market, the price has often already increased significantly.”
The first-day surge benefits institutional investors who get in at the offering price. Retail investors buying in the open market end up paying a premium right from the get-go.
“The process isn’t rigged, but it’s structured in a way that consistently advantages those with the most capital and the best connections,” Goldberger said.
In many cases, you’re buying an untested stock
One of the biggest risks for regular investors is that there are no trends or background information on the stock market to evaluate.
“IPOs are anything but a sure thing,” Goldberger said. “Many are priced based on projections and hype rather than an established track record. You’re buying a story, not a proven business.”
Main Street share buyers also face trading elements they’re not used to seeing.
“Watch out for the expiration of ‘lock-up’ periods,” Goldberger said. “The timetable windows, typically 180 days post-IPO, during which insiders and early investors are restricted from selling. When that window opens, a flood of shares can hit the market and drive the price down sharply.”
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Here’s why poor timing works against retail investors
Aside from being boxed out of the best IPO opportunities (2), regular investors have the clock working against them, too.
“It’s all about timing,” Andrew Bahlmann, co-founder at Deal Leaders International, said. “Typically, the time that most retail investors can purchase an IPO has passed before the retail investor can even think about buying.
“This means that the retail investor will likely be purchasing based on emotion rather than the underlying fundamentals of the stock.”
Retail investors often take the wrong mindset into an IPO
Regular investors usually treat an IPO like an event rather than an opportunity to invest in a company, and that’s the wrong approach.
“Investors that ultimately become successful typically spend far more time researching fundamental factors such as competitive position and growth estimates, rather than focusing solely on getting caught up in the ‘momentum’ surrounding the IPO,” Bahlmann noted.
Take Heed From Warren Buffett
Maybe the biggest mistake inexperienced IPO investors make is getting caught up in the hype and investing when everyone else is waving their checkbooks.
“As legendary investor Warren Buffett famously said, ‘Be fearful when others are greedy, and greedy when others are fearful (3),” Puckrin said. “Right now, everyone is very greedy when it comes to SpaceX and other major IPOs. That should be a red flag for retail investors.”
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Article Sources
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Pets (1); Stockopedia (2); Investopedia (3)
This article originally appeared on Moneywise.com under the title: ‘Very difficult’ for casual investors to gain with IPOs – why you should think twice about SpaceX, Anthropic and OpenAI
This article provides information only and should not be construed as advice. It is provided without warranty of any kind.
