IPOs Are Risky Business

With SpaceX's upcoming IPO, the financial world and social media are abuzz. But while many are proclaiming that the upcoming launch of the hybrid aerospace-AI company could send share prices out of this world, such wishful thinking is not guaranteed and could see prices crash back down to earth shortly after takeoff. Why? Because IPOs are risky business.

Prices Spike Before Falling Back Down

When a company first goes public, its stock price often rockets on the first day of trading. However, after the initial hype has settled, companies that recently went public often lag the broader market over the next three years, according to data from 2011 through 2024 on 1,724 IPOs.

Why does this happen?

The reasons why most companies that have recently gone public lag the broader market vary, but often stem from overvaluation at the time of the offering and from failing to meet market expectations. However, another factor can also be significant: lock-in expiration. 

When companies go public, company insiders are prohibited from selling their shares for 180 days, which is known as the lockup period. 

However, once the lockup period ends, the market has access to a larger number of shares available for trading, which may put downward pressure on the stock price as insiders cash out on their newfound wealth.

Many potential public investors forget that before a company reaches its IPO, it is funded by private backers who want their payday now that it is finally within reach. And, with regard to SpaceX, many private investors who have funded its existence to date are already anticipating large returns once they can cash out their positions. 

While early investors cashing out is reasonable and expected, such behavior, once the lockup period has ended and market hype has cooled, often leads to lagging stock performance.

What About XYZ Company?

While most companies lag the market after their IPO, unicorns exist, and some continue to outpace it. But such performance is never a guarantee, and unfortunately, no one has a crystal ball to predict the future. What seems like a no-brainer today may fizzle out and fail to launch after a few years. Investing in individual companies is a risky endeavor, and for ordinary investors, it is not practical.

Well, Then What?

If the average investor is better served by not investing in individual companies, what should they consider as an alternative? Simply put: a diversified portfolio made of ETFs and mutual funds that have exposure to a broad swath of equities and fixed-income markets.

While investing in funds that hold thousands of companies and bonds may sound boring, the track record for doing so has proven itself worthwhile over the past century. Should the regular person expect eye-watering returns? No, they should not. But investing is not gambling, and a well-diversified portfolio can often return 6-10% a year over the long term, which is how ordinary investors build wealth over the span of their working careers.

Your Next Steps

So, rather than chasing the next big IPO or speculative investment, consider building a long-term investment strategy that uses a diversified portfolio to match your risk tolerance over time. Such a strategy is not nearly as exciting, but it has proven itself worthwhile amongst many savers and retirees in our modern era. If you are unsure how to build a diversified portfolio or manage investment risk over time, we are here to help.

At Lundeen Abrams Advisors, we serve a broad range of clients with diverse goals and needs who have sought expert advice and investment management services. Please reach out to us by phone today so we can set up a consultation to learn what makes your situation unique and develop a strategy that will serve you long term. We look forward to speaking with and helping you soon.