Scanning regulatory filings for the next hot initial public offering (IPO) is often seen as too hard and waste of time. But reading the S-1 filings often gives insight into management and the inner workings of the company before the first earnings calls. With good research into the S-1, one may be able to identify sound companies that are ready to go public and may even be able to get an allocation of IPO shares. But, for every successful IPO – Amazon, Google, Facebook etc., there are dozens of failed IPOs – Blue Apron, Twitter, Snapchat etc. Furthermore, studies show that IPOs generally underperform the average for periods as long as five years after initial listing. And, it’s difficult to draw the line on what defines the “best” IPOs. Should it be one-year performance, or 10-year performance?
And so, should the average investor simply stay away from investing IPOs or is there value in adding IPOs to one’s portfolio?
Future Wealth’s View
Warren Buffett swears by the concept – “Circle of Competence“. This circle of competence consists of all the businesses with which the investor is familiar and thoroughly understands. If, for example, you know nothing about food industry, you shouldn’t invest in Blue Apron. Which explains why Buffett, who has professed ignorance of technology markets, missed out on Amazon and Google and, only lately and rather reluctantly, took a position in Apple.
Straying from the circle of competence leads into the land of speculation. And therein lies the problem. Many an investor clamored to get in on the Facebook IPO without any understanding of how the company makes money. The point is – if you are unfamiliar with the internet industry, don’t even attempt to evaluate the performance of an internet company, and forget about buying into the IPO of the company. If you do, it may turn out well in the long run as some Facebook IPO investors have found out. But, it was not from good research and analysis but, just pure luck. The next blind investment in a IPO may not turn out so well. Just ask Twitter investors.
When a visitor hopelessly lost in New York City asked a local guy (happened to be a music maestro) for directions – “Sir, how do I get to Carnegie Hall?”. The answer was “Practice, my friend, Practice”. Finding companies that are easy to understand is only the beginning. Then, comes the hard work and research. And, once you have done the due diligence – buy into the IPO and continue to follow the company closely i.e. quarterly earnings, product and customer announcements etc. and if all goes well, you may have the next Amazon in your hands.