IPO Fever
Every few years, IPOs have a way of making even the most disciplined investors feel a little like they’re standing outside an exclusive event, wondering if they should try to get in on the action. This is a recurring subject that pops its head up every few years. I actually wrote a blog about it five years ago (feels longer looking at how little my kiddos were!).
However, investor sentiment remains the same. So before we go looking for a side door to investing in the next IPO, let’s take a look at what’s really going on.
It usually starts the same way. A company announces that it will be going public, headlines start buzzing (with the intensity level of the buzz depending on the industry and the leaders of the company’s IPO), and suddenly it feels like everyone is talking about it. Before we know it, we are getting swept up in the excitement and are questioning, “Am I missing out if I don’t invest in this IPO?”
This is a perfect example of herd mentality or momentum investing, which aligns with our instinct as social creatures to go along with others. – Interesting side note, researchers at the University of Leeds conducted a study and found that “it takes a minority of just five per cent to influence a crowd’s direction – and that the other 95 per cent follow without realizing it.”
It’s a completely natural reaction. IPOs (Initial Public Offerings) are designed to generate excitement. But before making a decision, it’s worth taking a step back and looking at how they actually work—and things to consider when integrating an IPO in your long-term investment strategy.
The Basics
An IPO is simply when a private company offers shares to the public for the first time, and the stock is available to buy or sell on an exchange like the New York Stock Exchange (NYSE) or Nasdaq. Companies do this to raise capital (i.e money) to grow their business/fund future growth, pay off debt, or allow existing investors to sell some of their stake.
In the IPO process, the company going public will want to sell as many of their shares at the highest price they can get. The price of the stock is determined by an underwriting process taken on by large investment banks in which they ask questions around market status, company assets, history of the company, the company’s prospects for growth, etc. and then apply the rules of supply and demand (Economics 101 here!). They must determine the demand for the shares based on the supply of the shares that will be offered and eventually sold to investors. To get to the opening price point, the goal is to have the maximum number of trades be executed from all the placed orders. At Nasdaq, this is done electronically, while human traders are involved at the NYSE.
Getting a Slice of the Pie
Here’s where most retail investors (i.e – you, me, and our neighbor Joe) become surprised during the buying process. Not everyone has the same access to IPO shares.
In most cases, large institutional investors—like mutual funds and pension funds—receive the majority of shares. Individual investors may get a smaller allocation, or sometimes none at all.
Even if your brokerage offers access, there’s no guarantee you’ll receive shares. Some firms prioritize long-term or larger clients, while others use a lottery-style system.
From Fidelity:
“Several other factors may come into play when determining who receives an allocation of shares, including:
- Retail versus institutional split – IPOs are typically broken into 2 tranches of demand: institutional and retail. Institutional investors typically receive the lion’s share of any IPO allocation. Historically, the institutional-to-retail split is 90/10. However, the retail percentage can be higher or lower on a deal-to-deal basis.
- Media coverage – A deal that receives a lot of media attention and that involves a well-known company is often significantly oversubscribed. This means that demand for IPO shares far outweighs supply. In such cases, your odds of receiving an allocation of shares are greatly reduced.
- Type of offering – Certain types of IPOs, such as master limited partnerships (MLPs), real estate investment trusts (REITs) and business development companies (BDCs) can be more retail focused, so institutional investors are not vying for as large a piece of the offering. Therefore, retail investors typically have a better chance of receiving an allocation of shares in these types of IPOs.
- Directed share program allocations – In some cases, an IPO issuer may choose to direct a significant allocation of shares to existing investors or “friends” of the company. When this happens, it typically reduces the number of shares available to retail investors.
So while IPOs are widely talked about, getting in at the offering price can be a bit more complicated.
Why IPOs Get So Much Attention
Let’s be honest—IPOs are interesting.
There’s the appeal of getting in “on the ground floor” and “to the moon!”. There’s the possibility and most of the time hope of a quick jump in price. And often, it’s a company name you already recognize, which makes it feel more familiar.
Yes, sometimes IPOs do perform well right away. But as is often the case, the headlines tend to highlight the success stories—not the full range of outcomes.
The chart below shows the average returns for the 10 largest US IPOs for the 3 and 12-month periods post IPO date. Eeeeeeeek!
What Happens Once Trading Begins
Once the stock starts trading publicly, the price is determined by the market—and that’s where things can get a little unpredictable. Some IPOs rise quickly. Others dip below their initial price. Many experience noticeable ups and downs early on as the market figures out what the company is really worth.
A lot of that early movement is driven by demand, media attention, and investor sentiment—not just fundamentals.
A Few Risks to Keep in Mind
IPO investing isn’t inherently good or bad—but there are a few important things to keep in mind:
- Limited history: Newly public companies don’t have as much track record to evaluate, even if they are run by or tied to another company.
- Pricing can be tricky: Strong demand can push prices higher than long-term fundamentals might support.
- Lock-up periods: Early investors often can’t sell right away—but when they can, it can impact the stock price.
And perhaps the biggest factor: It is easy to get caught up in the excitement.
Keep in mind, IPOs are generally considered high-risk investments. Even the SEC website mentions, “An IPO gives the investing public an opportunity to own and participate in the growth of a formerly private company. By their nature, however, IPOs can be risky and speculative investments.”
One thing we often remind clients – you don’t have to invest in a company on day one to benefit from its success.
Waiting may not feel exciting—but it can often lead to more informed decisions. In our opinion, long-term success usually comes from consistency and discipline—not trying to time the next big headline. IPOs can be exciting—but they’re not a shortcut to building long-term wealth.
Trying to get into an IPO immediately could either leave you feeling like my daughter or my son after their first trip down a big kid ski slope. Ideally, we want to avoid the same kind of regret that my daughter was feeling.
