By Key Points
IPOs are a way for corporations to raise money by selling newly created shares of the company to any investor who wants to buy them at a predetermined price.
Despite the bullish buzz often resulting from an IPO, most of the highest-profile ones don’t perform all that well out of the gate.
A little common sense can help you determine which of these opportunities are worth the risk, and which ones aren’t.
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The enthusiastic trading activity surrounding Space Exploration Technologies‘ (NASDAQ: SPCX) recent IPO certainly wasn’t the first time I had witnessed the phenomenon. Indeed, I was involved in the markets all the way back in the 1990s and watched when a bunch of new technology stocks came to the market in response to the advent of the internet.
There’s no denying, however, that SpaceX’s IPO has rekindled investor interest in such opportunities. This raises the question(s): What exactly is an IPO anyway, and how do I pick winners when most of these newly available stocks are trading down a year later?
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What’s an IPO?
“IPO” is an acronym for “initial public offering.” That just means a company is issuing shares for the first time that will become publicly traded via a stock exchange.
In most cases, the purpose of an IPO is to raise capital from investors using an intermediary called an underwriter, or investment bank. In a small handful of cases, though, a public offering can be used to facilitate the sale of an insider’s or founder’s stake in a company. It’s the same either way for investors — a privately held company that you couldn’t invest in before becomes one you can buy into, by virtue of it “going public.”
Just be careful if you’re hoping to plow into the next splashy IPO like the ones rumored to be in the works for artificial intelligence (AI) names like OpenAI or Anthropic. While the bullish buzz surrounding both companies’ plans is palpable, the performance track record for most newly minted stocks isn’t all that great.
An analysis by financial advisor Edward Jones quantifies the concern, highlighting that between 2011 and 2020 — a decade when Facebook (now Meta Platforms (NASDAQ: META)), Snapchat parent Snap, and Twitter (now X) all went public — the typical technology company’s newly issued shares were priced down an average of 14% just six months after their IPO was completed. Separately but similarly, recent number-crunching done by Burney Wealth Management Managing Partner Adam Newman indicated that shares of the 10 biggest (as measured by the total amount of funds raised) public offerings every year since 2000 were down one year after their IPO, with an average loss of 27%.
That doesn’t mean that at least some of these stocks didn’t eventually go on to dish out some impressive longer-term returns, of course. For instance, Meta stock has been incredibly rewarding despite its rough start.
If you’re playing the statistical odds of participating in public offerings or buying into new stocks immediately after their IPO, though, know that the odds are stacked against you. SpaceX’s weakness in shares since reaching its post-IPO peak in June is proof of that.
Fortunately, there’s something you can do to help improve those odds.
How I filter out IPO winners
You never really know how the market’s going to see — and price — a new stock. But there are three tendencies I’ve observed that help me figure out which IPO stocks are likely to perform well and which ones aren’t.
1. It’s already a well-established business
Most initial public offerings are done by existing businesses. However, not all of them have been around a particularly long time. That makes it difficult to know whether they’ve got the staying power to keep investors convinced a stock is worth buying and holding rather than dumping it. Blue Apron, Stitch Fix, and Groupon come to mind as examples of companies that investors clamored for to go public before any had actually proven their business models could drive sustainable growth.
At the other end of the spectrum, many investors are surprised to learn that even though credit card giant Visa (NYSE: V) has been around in a recognizable form since 1958, it’s only been publicly traded since 2008. It’s been a particularly solid performer since then, though, leveraging its entrenchment and led by management with plenty of company-specific experience.
If you need an age range to start with, five to eight years’ worth of successful history seems like a smart minimum standard. That operating history requirement can be shortened by persistent profitability, of course.
2. The less hype, the better
Speaking of judgment calls, here’s another reality I’ve had to accept that you’ll need to as well: All too often, the greater the hype, the poorer the post-IPO performance.
This actually makes sense. Since more upfront hype inflates the perceived value of a stock, that ticker starts out at a price that’s even more unsustainable once it begins trading on an exchange. That’s when investors have time to dig deeper and absorb more information. Ironically, the less noise surrounding an initial public offering, the better. That usually means — for better or worse — its pricing is simply rooted in its past, present, and plausible future fundamentals. Take Legence, Park Dental Partners, and Pattern Group as examples. These are companies that most people have never even heard of, and they all went public last year. Yet all three stocks are well up since their 2025 IPOs despite their lack of notoriety.
3. The numbers must make sense
Finally, while it’s yet another judgment call you’ll need to make, investors should be encouraged by the fact that every stock’s price eventually makes some semblance of sense. If it’s initially overvalued, the market will correct the mistake. If growth is materializing, investors will gradually price that growth in as well.
That doesn’t mean young companies going through an IPO will be valued appropriately right out of the gate. Most won’t, in fact. You’ll need to rely on your experience and wisdom — and realism — to know when a steep premium is worth it and when it isn’t.
That being said, a particularly important numerical detail that must “make sense” is how the company is already spending its money, and what it intends to do with the money it raises from its IPO. If the public offering’s proceeds are going to be used to add production capacity for a product with proven demand, great! If it’s going to be spent on marketing and promotion of a product or service that’s already been around a while and just isn’t selling well, perhaps a lack of marketing isn’t the problem.
I’m reminded of GoPro‘s (NASDAQ: GPRO) 2014 public offering. At the time, investors were happy to hand over more than $400 million to the touted maker of high-end action cameras “for general corporate purposes, including working capital, and to repay our term loan [$111 million at the time] under our credit facility.” A closer look at its filing would have revealed, however, that even after being in business since 2004, its single-biggest operating expense was still (by far) sales and marketing. No one denies its action cameras were and are of the highest quality. That level of spending on promotion simply suggested that most consumers just didn’t need or want a high-end action camera. Spending more on it wasn’t likely to help.
And it didn’t. That’s why GoPro shares are now trading more than 90% below their well-hyped IPO price.
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James Brumley has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Meta Platforms and Visa. The Motley Fool recommends Stitch Fix. The Motley Fool has a disclosure policy.
