With every market cycle, comes a new crop of IPO stocks to watch. In earlier years, we saw much-hyped IPOs from Facebook (FB), Snap (SNAP) and Square (SQ). Today, we see newer companies like Zoom Video Communications (ZM), Bandwidth (BAND), Beyond Meat (BYND), DocuSign (DOCU), Datadog (DDOG), Peloton (PTON), and Vroom (VRM).
When an initial public offering launches, it's important to keep in mind a key fact regarding new IPO stocks: Big-buzz IPOs don't always live up to their hype — at least not at first.
Whether it's Zoom, Beyond Meat, Datadog, DocuSign or a brand-new IPO like Vroom, which started trading on June 9, whenever a new group of IPO stocks comes along, it's important to understand that market reality. The value of staying patient has been shown again and again in big-name stock market debuts like those of Facebook, Alibaba (BABA), Snap and Square.
Immediately buying into an IPO stock as soon as it goes public is a high-risk proposition, regardless of how convincing the hype may seem.
Facebook, Alibaba, Snap, and Square all headed south from their second week of trading, providing clear examples of why you should wait for a new IPO to form its first base before you invest. Uber Technologies (UBER) and Lyft (LYFT), as well as Warren Buffett-backed StoneCo (STNE), followed a similar trajectory, only reinforcing the value of this rule.
Track IPO Stocks
Investors should always keep this rule in mind when evaluating IPO stocks like Uber, Lyft, Beyond Meat, Vroom and Dynatrace (DT).
Like Facebook and Alibaba before them, both Dynatrace and Peloton stocks ran into resistance right after going public. Even IPO stocks like Beyond Meat, Zoom, and DocuSign jumped out of the gate with a good start, but soon encountered some turbulence. They all proved that you want to let a stock establish some trading history and form a chart pattern before you buy.
From its IPO in May 2019, Beyond Meat bolted higher for over two month, then got slammed in August. The stock is showing signs of recovery now, but that's after Beyond Meat gave back virtually all of its gains from July 2019 to March this year.
Reinforcing the volatility of IPO stocks, Peloton is once again trading near a new all-time high, but that's after the stock crashed from December 2019 to March.
Famed jeans maker Levi Strauss (LEVI) returned to the public markets with an IPO on March 21, 2019. The San Francisco-based company closed over 6% higher in its second week, but has struggled since then.
The moral of these stories is simple: Don't buy into Uber, Peloton, Beyond Meat or any other IPO stock on its first day of trading, hoping it will just zoom higher. You can reduce your risk and still capture plenty of rewards if you simply wait for the stock to prove its strength by forming and breaking out of a base.
Given their volatile nature, always remember that if you are going to trade IPO stocks you need to follow a sound set of sell rules.
Big-Buzz IPO Stocks: Lessons Learned
From its first weekly close on May 18, 2012, Facebook sank 54% over the next four months. Snap plunged 48% from its first weekly close on March 3 of that year until apparently finding a bottom in August, 2012. And after closing out its first week of trading on Nov. 20, 2015, Square fell 37% over the next 10 weeks.
Keep in mind that if you take a 50% loss, you need a 100% gain just to get back to break-even.
Alibaba fared better when it went public in September 2014, declining just 12% from its first weekly close while forming an IPO base. The stock did offer a buying opportunity when it broke out of that pattern in October. But the Chinese internet giant soon provided more proof that IPO stocks can be quite volatile.
After quickly rising as much as 20%, Alibaba reversed course, falling 47% from November 2014 until it found a bottom in September 2015. The stock continued to struggle. It didn't really get going until it launched its current run with a breakout at the beginning of 2017.
Patience Pays Off
Although many investors chose to ignore it amid all the buzz, Facebook flashed a serious warning sign before its IPO: a sharp slowdown in earnings growth.
In the three quarters before going public, the company's EPS gains slowed from 100% to 25% to 9%. And in Facebook's first two reports as a publicly traded company, it posted 0% growth.
It wasn't until about 14 months after its initial public offering that Team Zuckerberg finally found its mobile mojo. It then delivered a return to growth with earnings of 13 cents a share on a 58% gain in revenue for Q2 2013.
Facebook bolted out of a double-bottom base on that report and made an impressive multiyear run. The stock is now trading right around a new all-time high.
Square Took Off After Earnings Grew
Interestingly, it also took Square about 14 months of roller coaster action before it found its market legs and began to climb. It's no coincidence that the provider of payment-processing software started to move as its earnings growth began to improve.
After its breakout in February 2017, Square rose nearly 550% before entering a sharp downtrend in October 2018 as a bear market took hold. Square is now rebounding from the coronavirus crash and is approaching a new all-time high.
And then there was Snap.
After heading due south for months after it went public, the Snapchat parent seemed to have found a bottom in August 2017. It then popped in early February 2018 on its Q4 earnings report. But Snap once again broke down and failed to find support at its 10-week line. It wasn't until late 2018 that the stock established a new bottom and began showing signs of a rebound.
In addition to its chart action, keep in mind that unlike Alibaba, Facebook and Square, Snap has no profits. So while Snap may go on to make a nice run, the jury is still out. But after a long slump that included the coronavirus stock market, the social stock is showing signs of a rebound.
Make An IPO Prove Itself Before You Buy
Buying a brand-new IPO can be tempting, but it can also be costly and painful.
As the examples above show, you can significantly reduce your risk and still reap plenty of rewards if you follow these three steps:
- Don't buy an IPO stock until it forms and breaks out of its first base.
- Focus on profitable companies showing technical strength.
- Cut losses short if the trade goes against you.
In other words, just like with any stock, make IPO stocks prove their fundamental and technical strength before you invest.
If the pre-IPO buzz turns into a bust, you'll be glad you stayed out. And if the hype turns out to be true, you'll still have plenty of chances to profit.
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