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What is an IPO and Should You Invest?

Over the past few months we've seen 3 companies go public; Beyond Meat, Lyft, and Uber. Some companies’ stock did well, while others took a hit. Because of the great economy we are experiencing right now, many have seen this period of time to be a good time to take your company public and these 3 companies did just that. In today's post, we'll look at what an IPO is and what are some of the pros and cons of investing in them.

What is an IPO?

IPO stands for Initial Public Offering. According to Investopedia, "An IPO is the very first sale of stock issued by a company to the public. Prior to an IPO, the company is considered private, with a relatively small number of shareholders made up primarily of early investors (such as the founders, their families and friends) and professional investors (such as venture capitalists or angel investors)." An IPO is usually a big deal and usually, only private companies with strong fundamentals and proven profitability potential could qualify for an IPO.

Not everyone has the ability to take advantage of IPO’s. There are certain requirements and things regulators look for if a company wants to apply and go through that process. Once a company has been approved, they usually go on what’s called a roadshow where they are telling big investors why they should invest in their company. It is essentially a big marketing campaign. Then it is usually announced in the news that the company is getting ready to go public on a certain date.

In the example of the 3 companies above, none of them have produced a profit yet but were still able to go public. So why would a company decide to go public?

There are a few reasons, but two of the main reasons are that going public raises a great deal of money for the company which allows it to grow and expand. As a private company you can borrow money and take out loans, but it is hard to generate a large sum of money very quickly like you can from doing an IPO. For example, Beyond Meat just raised $240 Million, Lyft raised $2.34 Billion, and Uber raised $8.1 Billion from their IPO's. Another reason for an IPO is that it can be an exit strategy for the company founders and early investors to profit from their early risk-taking in a new venture. Therefore, in an IPO, many of the shares sold to the public were previously owned by those founders and investors.

Now we will look at the pro's and cons of an IPO from an investor's standpoint:

Pro's

Flipping the Stock

  • One option you have is to buy the stock at its price when it goes public and if the stock soars in the first couple of days you can sell it for a profit. For example, Beyond Meat's initial stock price was $25 and the high was $85.45. If you timed it perfectly and sold at the high, the return on your money would have been 241.80%!! It is rare that you find investments that can give you that rate of return in such a short time span. It was also one of the best performing IPO’s in nearly two decades.

Long Term Growth Potential