Tread Carefully in a Hot IPO Market
Kiplinger's Personal Finance|March 2021
Be wary of high-priced debuts in a market that’s stacked against you.
Adam Shell

IT’S 2021, BUT ON WALL STREET it feels like the exuberant days at the turn of the cen­tury. Initial public offerings (IPOs) are hot again. A new wave of young companies, many that have yet to post a profit, are selling stock to the public for the first time. And the reception from in­vestors has been bullish.

Maybe too bullish, IPO watchers warn. “There’s definitely froth” in the mar­ ket, says Lindsey Bell, chief investment strategist at Ally Invest. The market’s power­ful rebound from last year’s pandemic­related plunge put investors in a buying mood. Eye­popping IPO gains are fueling the hype.

Big first­day pops have caught investors’ attention. Shares of Airbnb jumped 113% and food­delivery ser­ vice DoorDash rose 86% in their trading debuts late last year. The average first­ day return for IPOs in 2020 was nearly 42%, the best day­one showing since 2000, according to Jay Ritter, finance professor at the University of Florida. Last year’s average annual IPO gain of 75% was the highest in 20 years, accord­ ing to IPO experts at Renais­sance Capital. The 218 IPOs in 2020 were the most since 2014, and IPO momentum will likely continue in 2021 amid expectations for an im­ proving economy and strong market as the COVID­19 vaccine rolls out.

Don’t buy into the hype. For every high­profile IPO that doubles on its first day, there are many newbie stocks that disappoint in­vestors. In fact, the long­ term performance of IPOs is underwhelming. About half of IPOs “will produce negative returns” in their first five years as public companies, Ritter says. “My advice now is to stay away from IPOs,” he says. His caution stems from expen­sive valuations that tend to limit future gains. Investors are again paying top dollar for tech IPOs. The median tech IPO in 2020 at its first­ day closing price traded at 23.3 times sales—more than three times higher than average, Ritter says.

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