With the recently highly hyped Snap Inc. (NYSE:SNAP) initial public offering, I was once again reminded why I don’t attempt to buy into IPO's.
While big name company's first offer their stock to the general public, its call an initial public offering, or an IPO. While there are a number of issue's with buying stocks the first day they start trading, the biggest one is the hype!
The hype surrounding a big name IPO, such as Snap, Facebook, or Twitter to name a few, is that the demand for shares outweighs the supply on the first day of trading. Millions of people want shares and most fear if they don’t get them early, they will miss a big move higher. This hype and fear frenzy often causes shares to skyrocket in the first minutes to hours of trading. Snap for example rose 45% on day one.
But, after the hype fades, so will the stock price. The demand declines to the point that those looking to sell have to be willing to part ways with their precious shares for much less than they sold for on day one. Snap fell 27% on its second day of trading.
But, IPO's can get worse. When a company goes public, it offers so many shares to whoever wants to buy them in an attempt to raise capital for the company. Insiders and early investors aren't typically allowed to sell their shares of the company on day one. They have to abide by certain lock-out restrictions which usually expire months later after the initial public offering. (Typical lockout periods are 90 days to 180 days).
Once these lockout periods expire, the open market can again be flooded with shares for those insiders or early investors who now want out of the stock. This can again throw off the supply and demand and usually a stock will fall after the lockout period when supply is once again greater than demand.
But regardless of the risks associated with investing in IPO's, some investors still want to play the game. Lucky, they can with the diversity and increased protection of Exchange Traded Funds.
Two Exchange Traded Funds that buy recently IPO'ed stocks are the Renaissance IPO ETF (PACF:IPO) and the First Trust US Equity Opportunities ETF (PACF:FPX). While both funds buy recent IPO's, they both have different holding periods and other criteria that is important to know before buying either ETF.
The Renaissance IPO ETF acquires recent IPO's within 90 days or sooner and holds for two years while First Trust (FPX) will hold stocks for four years. IPO typically has a larger concentration in a few stocks, while First Trust spreads it cash more evenly. Currently IPO has 46 holdings while FPX has 102. Both charge the same in terms of expense's at 0.6%, but FPX has a much higher distribution yield of 0.83% compared to just 0.3%.
IPO also currently carries a higher price to earnings ratio, 84.3 at this time, compared to 33.3 for FPX. FPX is also a much, much larger fund with nearly $700 million in assets under management while IPO only has $13 million. But, when it comes to performance, IPO holds the edge. One year performance of IPO is 20.79% compared to 16% for FPX and year to date IPO is up 11.67% while FPX has increased just 6.53%. (Looking out longer is not prudent since IPO has an inception date of October 2013.)
One issue with these ETF's is that they unlikely will get access to the Initial Public Offering Allocation's or pre-IPO equity, meaning if a stock pops like SNAP did on day one, the ETF is not benefiting from that and may end up just paying an inflated price down the road.
While both IPO and FPX offer investors another good option to play the IPO market, they need to remember that recently public companies tend to underperform the market. An ETF will help reduce some of your risks, but it will not eliminate risk altogether.
Disclosure: This contributor held long positions in Apple, Tesla, Intel, Google, Amazon.com, Facebook, Priceline and Microsoft at the time this blog post was published. This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.