It’s Going To Be A Hotter Year For IPOs: Here’s How To Make The Most Of It

Let’s face it: the past two years have been a cold spell for initial public offerings (IPOs). With interest rates on the rise – thanks to the Federal Reserve’s (the Fed’s) battle against inflation – investor enthusiasm for stock debuts had all but frozen over. But now, with those rate hikes mostly behind us, things look to be warming up again.

How is the IPO pipeline looking for 2024?

A whopping 257 potential IPO candidates could come to market this year, according to CB Insights. Of those, more than half were last valued between $1 billion and $5 billion, and another 38% between $1 billion and $3 billion. We’re talking big companies, ones that could make a splash and stir up investor excitement. And yes, about three of every five of them will list in the US. But overall they’ll be truly global. Case in point: India has the second-most debut candidates on the list, with 31.

So expect a vibrant year ahead in the public markets, with an eclectic mix of industries and geographies represented.

Here are some of the highlights among the firms that could start trading this year (and why they’re making a buzz):

Shein, the trendsetting fast-fashion retailer, and Skims by Kim Kardashian are reimagining the clothing industry. In the financial tech landscape, giants like Stripe, alongside Klarna and Revolut, are revolutionizing payment processing and banking. Cabify and Bolt are driving advancements in transport, while Patreon, Kajabi, and Discord are becoming cornerstones of digital community building. Strava’s social platform is energizing the fitness world, Databricks is innovating in big data, and emerging players like marketing automation specialist Klaviyo, banking app Chime, and cloud data management expert Rubrik are ready to showcase their unique tech contributions.

This chart has a fuller list:

The 257 potential IPO candidates identified by CB Insights. Source: CB Insights.

Should you get your IPO dancing shoes on, then?

You might want to hold your, uh, dancing horses here. IPOs can be a thrilling ride, no doubt about it. They’re often young, buzzy companies at the start of their growth spurt. And, there’s a commonly held idea that getting in on an IPO is like snagging a front-row seat to the next big thing.

But here’s the thing: excitement doesn’t always mean a smart investment. Despite those first-day trading spikes, research by “Mr. IPO” Jay Ritter suggests that IPOs tend to have a poor long-term track record for investors. From 1980 through 2022, the majority of IPOs lost money over the three- and five-year periods that followed their debut, with 37% losing more than half their value over three years. He found that the average IPO stock bought at the publicly available closing price on the first trading day returned about 6% annualized over three years. Meanwhile, an index of all U.S.-listed stocks returned about 11% annualized over the same period. Put more simply, you’d have been better off simply buying the index.

Research by Phil Mackintosh at Nasdaq found similar results:

The longer the holding period, the more disappointing. Sources: FactSet, Nasdaq Economic Research.

And, look, there are a couple of reasons why IPOs don’t live up to the hype. For starters, most retail investors can’t buy in at the offer price. These shares are typically reserved for big institutional players and maybe some select retail investors who are sitting on piles of cash and have the right connections. For the average Joe or Jane, getting in at this stage just isn’t possible. And, usually, by the time these stocks make their grand entrance on the open market, their prices have already spiked. So if you’re a regular retail investor, you’re probably buying in at a price that’s way less juicy. And that can have a huge effect on your returns: Ritter found that jumping in at the first day’s closing price, rather than the initial offer price, can slash your three-year returns by nearly half.

Another reason is the existence of lock-up risk: bigwigs like founders, employees, and early bird investors are usually handcuffed from selling their shares for a few months post-IPO. And once that lock-up period ends, there’s often a mad dash to sell, flooding the market with shares and – you guessed it – driving the price down. And don’t forget about the tug-of-war in interests, with venture capitalists, underwriters, and early investors itching to cash out big at the IPO.

Last, new kids on the stock block often come with limited info and trading history, meaning their early prices are more easily driven by sentiment, rather than fundamentals. That makes it more of a popularity contest than anything else. And behavioral biases increase the risk of an overhyped company trading above its fundamental value. After all, many investors forget that for every Tesla, there is at least one WeWork (the company lost 99% since its 2021 debut and recently filed for bankruptcy). There’s a reason why legendary investor Warren Buffett has called investing in IPOs “a stupid game”.

So what’s the opportunity?

The sad truth is that the IPO playing field isn’t exactly level. But that doesn’t mean every IPO is a no-go for the everyday investor. Picking the right one can still be a win. Now, don’t expect any secret sauce or magic formulas here. However, I’ve dug deep into Ritter’s data, and I’ve discovered four simple things you can do to tip the scales in your favor:

Steer clear of SPACs. Think of a SPAC as a “blank-check” firm, set up to raise capital through an IPO, to acquire a private company. They’re known for being more efficient and facing fewer regulatory hurdles than traditional IPOs. However, SPACs are often not great investment choices. From 2012 to 2020, there were 451 SPAC IPOs – and the average investor saw losses of 45% after one year and losses of 57% after three years. That’s a tougher hit than you’d get with traditional IPOs.

Watch those sales figures. Companies raking in over $100 million in sales usually fare better post-IPO (with the exception of the biopharm startups). So it’s worth remembering that the smaller the company, the riskier it tends to be.

And keep an eye on profitability. Companies that are already profitable when they go public tend to do better. On average, unprofitable firms have shown barely any returns over three years, while profitable ones have notched an average of 34% gains. And that’s far better, but it’s still below general market performance.

Remember: tech is your friend. Historical stock data leans pretty favorably toward tech sector companies. They’ve generally outperformed those in other sectors after the debut day.

So, here’s the bottom line for buying into IPOs, especially if you’re not getting in at the offer price: your safest bet is to aim for big, profitable, tech-sector companies.