IPOs – sound investment or risky speculation ?

Unless you’ve been sequestered for the past few weeks, you have no doubt have heard about the train wreck that is WeWork. This is the company that provides shared workspace. The idea is simple. Rent out really expensive real estate in major cities. Transform it into trendy shared office spaces and then rent it at affordable rates to lots of small companies.

So why is WeWork in the news? Essentially, in the process of trying to sell stock in the company to the public – in a process called an initial public offering – all sorts of damaging news came to light. From its erratic alcohol and pot-fueled chief executive officer to its shady business dealings the issues were just TNTC.  The end result is that the CEO and his posse are out and the company is probably not going public any time soon. But what exactly is an initial public offering and why is there so much excitement about them?

What is an initial public offering (IPO)?

Most companies start out small with funds scraped together by their founders. Apple started in Stephen Job’s parents garage. Legend has it the venture got funding by selling Job’s Volkswagen microbus and Wozniak’s HP calculator. Ironically, HP also started in a garage under similar circumstances. As companies grow, they need more funds. Initially, that may come from outside investors; however, eventually the company needs more capital to fuel its growth. This is where an initial public offering (IPO) comes in. 

In an IPO, a privately owned company offers it stock to the public for the first time. This is the process in which a company “goes public.” It allows companies to raise money for growth and can also make its founders rich. Unfortunately for WeWork, its also the time when the public really gets its first look at the inner workings and finances of the company. 

Why IPOs cause so much excitement?

There so much excitement surrounding IPOs because sometimes folks make a lot of money. Look at Beyond Meat, which went public in May 2019 for about $45 and by August soared to about $234. Although it’s stock price has had wild gyrations -its worth about $151 today- IPO buyers did quite well. The problem is that for every Beyond Meat there is a PETS.com. If you don’t remember PETS.com it was an online merchant that sold pet supplies.  It went public in February of 2000 for $11 a share and by November was bankrupt.  A company doesn’t have to go bankrupt to be a bad bet. Two of the most notorious IPOs are Facebook and Snap. Facebook had IPO price of $38 a share and within days was worth about $18. Snap experienced an even more dramatic plummet.  Both are good companies. Both were terrible IPOs. 

Should you invest in an IPO?

Buying an IPO is like gambling at a casino. People love to gamble. They love the entertainment, the excitement, and the thrill of possibly winning. They are also particularly bad estimating the risks. Casinos are built to take money out of your pocket and into theirs. And yet people keep going. The same is true for IPOs. Sure, once in a while the public makes money on an IPO. But you know who always makes money? The stock sellers and the financial companies that help them. It’s designed that way.

Should you get involved in IPOs? Unless you are comfortable walking into a casino and plopping down your nest egg on the roulette table, the answer is an unequivocal NO!  IPOs should be viewed as  highly speculative and with great skepticism. Stick to disciplined investing and leave the speculation to others.