Financial Adviser: 5 Myths About Investing in IPOs and Strategies on How to Make Money from Them
Investing in initial public offerings (IPOs) can be a lucrative opportunity to make money in the stock market, but it also carries risks and misunderstandings that require careful consideration.
Misconceptions about IPOs can lead to unwise investment decisions and financial losses. This is why it is important for every investor to distinguish facts from fiction when investing in an IPO.
Although buying IPO stocks can bring profitable returns, investing in IPOs require patience and a long-term perspective. If you want to succeed in this approach, you must get to know the company well by doing proper research.
You can do this by reading the prospectus of the IPO where you can find latest financial reports of the company, as well as its plans in the future. By doing this, you will be able to assess the company's financials and growth prospects.
Investing in IPOs should be viewed as part of your overall personal financial plan. It is important that you evaluate your financial goals and risk tolerance before deciding on how much money you are willing to invest.
When you understand the realities and myths of IPO investments, you will have a higher chance of surpassing market expectations and achieving your financial objectives.
What are the common misconceptions surrounding IPO investments? What steps can you take to minimize the risk of making unfavorable investment decisions?
Here are the top five myths that every investor should be aware of and some helpful tips on how to capitalize on IPO investments to generate income.
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Myth #1: IPOs always make money
It is a common misconception that investing in IPOs is a surefire way to make money. However, this is not always the case. While some IPOs can skyrocket in value, most IPOs underperform or even lose value.
If we will look at the IPOs last year, eight of the nine IPO stocks ended the year with losses. These stocks were Balai ni Fruitas (PSE: BALAI), -17 percent; Vista REIT (PSE: VREIT), -5.7 percent; Raslag Corp (PSE: ASLAG), -17 percent; CTS Global (PSE: CTS), -4 percent; Bank of Commerce (PSE: BNCOM), -34.3 percent; Citicore REIT (PSE: CREIT), -10 percent; Figaro Holdings (PSE: FCG), -16 percent; and Haus Talk (PSE: HTI), -28 percent.
The only IPO that managed to end on a positive note in 2022 was Premiere Island Power REIT (PSE: PREIT), which gained by 6.7 percent.
Buying an IPO at offering price does not mean you are buying it at the lowest price. The offering price of an IPO is simply the value that the owners of the company are willing to sell to the public. You may or may not agree with the price, depending on how you would evaluate the merits of the offer
IPOs can be volatile and unpredictable, especially during their first few months of trading. It is important to do your due diligence and study the company's financials, management team, and industry before investing. Additionally, it is crucial to have a long-term investment strategy in place to ride out any potential volatility.
Myth #2: IPOs are always underpriced
IPOs are perceived as inherently good investment opportunities because they provide the investor the chance to buy the stock at the “ground floor.”
Sure, there have been IPOs in the past that have doubled or tripled shortly after listing but there are also many newly listed stocks that went downhill right from the start.
One case example of this is the IPO of Medilines Distributor (PSE: MEDIC). When MEDIC was listed on December 2021, it opened immediately at a loss of 13.5 percent from its IPO price of P2.30 per share. The stock was bombarded with heavy selling on its first day, ending the day with 30 percent loss.
Since its listing date, MEDIC has never recovered as its stock went on a downward trajectory until today (end-February 2023) at P0.68 per share, representing a loss of 70 percent in value from its IPO price.
While it is true that some IPOs are underpriced, meaning that their shares are priced lower than their perceived market value, not all of them are.
Also, underpricing an IPO can also be a sign of weak demand for shares, which may not bode well for the company's future performance.
We need to remember that underwriters and issuers price their IPOs based on investors’ demand to make sure the final offer price is aligned with market expectations. When sentiment is low and there is high uncertainty in the market, IPOs tend to be underpriced.
Myth #3: IPOs need to have an attractive financial track record
Another common misconception about IPOs is that they need to have an impressive financial history. The success of an initial public offering (IPO) is influenced by a range of factors.
A low Price-to-Earnings (PE) ratio or strong fundamental indicators may make an offer price appear attractive, but these factors alone do not guarantee superior performance.
Sometimes the success can be attributed to the track record of its owners and management team. One case example of this is the IPO of DoubleDragon Properties (PSE:DD), which did not have a history of financial performance because it was organized as a startup company.
But the demand for the IPO was high because of the strong track record of its founders, Edgar “Injap” Sia of Mang Inasal and Tony Tan Caktiong of Jollibee.
So when it was listed in April of 2014, the IPO almost doubled its share price on its first day from the offer price of P2.00 to P3.84 per share. The strong expectations of investors supported the stock’s continuous ascent for two years that increased its share price to as high as P80 per share in 2016.
Investing in IPOs can be risky and unpredictable because of the lack of track record in the stock market. Because of the unknown risks that come with newly listed stocks, investors expect higher returns from IPOs to cover the higher risks.
Myth #4: IPOs are only for long-term investors
Investing in an IPO does not always result in long-term gains. Since a new company lacks a track record, there is no assurance that it will perform well financially in the future, which in turn affects the performance of its stock price.
Historical IPO data from the Philippine Stock Exchange for the past 10 years show that newly listed stocks have a 59-percent chance of closing higher on first day, gaining an average return of 7.2 percent above the offer price.
But after one month, the chance of possibly sustaining an uptrend is cut to 56 percent with average cumulative gain of 12.5 percent. This trend continues to weaken to 50 percent in the following month with total cumulative returns of 13.7 percent.
Based on this experience, it would appear that the first few months is the best time to assess the long-term performance of the stock. IPOs have a historical tendency to take a firmer trend either upward or downward after this period.
A case example of this is the IPO of Pilipinas Shell Petroleum (PSE: SHLPH). When it was listed in November 2016, its stock price gained by 8.9 percent from offer price of P67 per share to a high of P73 per share after one week.
This upward trend was sustained for three months until it peaked at a high of P80 per share. From there, the stock began to decline over an extended period. Today, seven years since its listing, SHLPH is trading at only P17.20 per share, representing a loss of 78.5 percent from its all-time high price.
Myth #5: Investing in IPOs is not the same as investing in a well-established company
IPOs are riskier than investing in a well-established company. Investors should be prepared for volatility and potential losses.
IPOs do not have a trading history. There is no way for you to evaluate how the market will judge the stock until it is listed.
Some IPOs may be perceived to be relatively cheap based on growth prospects while others may be seen as expensive. Until the IPO is finally traded on the stock exchange, you will never know where the stock is going.
When you invest in an IPO, it is important for you to define your investment strategy. IPOs can be volatile in the first few weeks of listing. It can shoot up high quickly or fall immediately. You need to manage your risk by setting a target price to sell. If your stock falls badly, you also need to set a price to cut your losses.
Ideally, you need to sell your IPO at a good price when you have the opportunity to do so because it may not stay that way for long. Every IPO has a lockup period which prohibits company insiders, such as officers and employees, from selling their allocations.
Lockup period normally lasts a year, so when this period expires, you can expect the insiders to cash in on their profits. When this happens, there will be tremendous downward pressure on the stock price because of the excess supply in the market.
This is what happened to Converge ICT Solutions (PSE: CNVRG). The IPO of CNVRG was a huge success. Its share price rose steadily month after month since day one from an offer price of P16.80 per share to as high as P45.40 per share, gaining over 170 percent return.
But after one year, when the lock up period expired, CNVRG went downhill over the next 12 months, falling even lower than its IPO price last year to P12.46.
Today, CNVRG has come back to earth after a period of excitement with its share price trading at slightly less than its offer price of P16.80 per share.
Despite this, CNVRG’s financial performance has been strong, with a 17 percent increase in net earnings for the first nine months of 2022, reaching P6.1 billion compared to P5.2 billion in 2021 supported by a strong revenue growth of 30 percent.
Henry Ong, RFP, is an entrepreneur, financial planning advocate and business advisor. Email Henry for business advice [email protected] or follow him on Twitter @henryong888