IPO FOMO
Our dog Dude is a reeling ball of energy, not surprising given his breed as a Blue Heeler and their intuitive need to be constantly occupied with a job or a purpose. As of right now we don’t have any field animals for him herd, so by default he has latched onto our two kids lovingly. However, instead of putting any order to the chaos that is life with toddlers, he tends to suffer from cases of FOMO (fear of missing out) or “shiny object syndrome” and instead morphs into what I call my third “child”.
With the recent high volume of Initial Public Offerings this year (already 672 IPOs for 2021 so far!), it is not surprising there is a lot of FOMO going on with investors related to buying into the newest, hottest, and “shiniest” stock – particularly as DIY / retail investing has become more popular over the last year and investors have seen some IPO prices “pop” in the first day of trading. This “pop” is when the average investor starts to really experience the strongest fear of missing out, but it is also the point of maximum financial risk (see the below chart).
The fear of missing out is also largely fueled by the hindsight bias that is established through past experiences or tales lamenting choices like, “I almost bought AMZN when it was trading for $4/ share, I wish I had bought it back then. I would be rich.” However, this type of thinking suggests extreme diligence in that the investor trusts they will hold the stock for an extended period of time and will have never realized any of their gain.
However, only 38% of major IPOs have had higher Annualized Returns than the S&P 500.
And while there is still a number of outperforming IPOs, it is also important to note that individual investors rarely get to buy the IPO at the offering price and if so, it is usually less than 10% of the available shares. Banks underwriting the IPO set the offering price and give out most shares at that price to their best (aka largest) customers like mutual funds and hedge funds. Of course, there will always be an exception to the rule, such as Robinhood (HOOD), offering over 300,000 users, making up 25% of the shares, to participate in the IPO.
Another factor affecting IPO returns are the potential for “lock-up” or “black out” periods which prevents early investors and insiders from selling their shares until approximately 90 – 180 days after the IPO. Once this period is over with, more shares are available for sale in the open market which could push pressure on the price of the stock.
This is of course not to saying that buying a stock that has recently had an IPO is always going to result in a loss, rather it can be the length of time you hold the stock. For example, if you bought Facebook’s IPO, it took 15 months for the stock to get above the original offering price. And compared to other IPOs, that’s a quick turnaround: research firm IPOX Schuster took data from the period of 1985 to 2019, and nearly 57% of IPOs in a 48 month period had negative returns.
If you are reading this, then you (hopefully) know Meridian does not believe in “get rich quick” investments or timing the market, rather we believe in taking a diligent, prudent, and diversified investment approach where time in the market beats timing the market.
All of the highest returning stocks started out as an IPO at some point; however, when it comes to “shiny object” stocks and battling FOMO with IPOs, it’s important not to forget the importance of fundamentals such as a company’s earnings and profitability as well as your own ability to stomach larger amounts of undiversified risk and volatility in the shorter (or in some cases) longer term.