Robinhood’s Lackluster IPO
It was a busy week across the financial markets to round out July. A clampdown by the Chinese government on several industries hit its equity market hard. Several key US economic data points kept analysts busy. Meanwhile, corporate earnings season was in full swing (with much better than expected numbers, by the way). Finally, in Washington, an infrastructure package was put forward that appears to have legs.
And then there was the Robinhood IPO. IPOs (initial public offerings) often command attention from investors for their first-day share price pop that often happens. But not this time. Shares of Robinhood (ticker: HOOD) sold off on the first day of trading last Thursday.
Why Go Public?
For some background, a successful private business often seeks an exit strategy for its founders when it grows large and successful. The owners want to score a big payday while reducing their risk. From a diversification perspective, it’s not necessarily wise to have all of your eggs in one risky basket like a private business. In fact, TFC works with small business owners to manage taxes and other strategies. We don’t take firms public on the stock exchange though—apologies there.
For owners of a single concentrated position, an IPO is a viable exit strategy along with a secondary buyout or corporate acquisition. This year has been particularly hot for the IPO market as more firms seek access to the secondary equity market. Investors are willing to pay a pretty penny for newly public companies, luring owners. The pandemic also spurred a record number of small business applications, so naturally more IPOs should have been expected.
Surge In New Businesses (J.P. Morgan)
Robinhood’s Tale
As for Robinhood, investment bankers who underwrite the offering priced shares of the popular stock trading app company at $38 last Wednesday night. On Thursday morning, the Nasdaq exchange opened it for trading. After a brief jump to $40, the share price fell under the $38 IPO price, eventually settling at $35.15 by the close on Friday, disappointing those who were allocated shares at $38.
Shades of 2012 & Facebook
Seasoned investors might recall the Facebook IPO more than nine years ago. Highly anticipated, Facebook began trading in May 2012, but it was a struggle that first trading day when the Nasdaq exchange failed to properly handle intense investor demand. The rest is history though, as Facebook stock has soared. We certainly aren’t saying that will happen again, but it goes to show that the first day of trading is often not a sign of the future.
Are IPOs Good Investments?
Aside from the anecdote of Facebook’s IPO, broader data suggest IPOs are a pretty raw deal for investors like you and me. Professor Jay Ritter at the University of Florida is an expert on IPOs. Research finds that following a first-day jump, IPO stocks often underperform the market in the following six-month and five-year periods according to Ritter’s data.[i]
The solution is to turn off financial news; watch the Olympics, a Tigers game, the Weather Channel. The financial news covers IPOs like they are precious gems when they are really like lumps of coal for investors. While IPOs are a great exit strategy for company founders, the data show they are not solid long-term investments. Better to stick with low-cost, diversified funds that pay dividends.
The Point
If you are a business owner looking to diversify your assets, an IPO could be a good route. Other financial planning strategies can help you manage risk, too. For investors, IPOs are entertaining but can be damaging to your wealth if you get caught up in the near-sighted hoopla. Let’s focus on the long-term plan.
As a reminder, check out our new CFO and tax services for business owners.
We’ll talk soon!
[i] https://finance.yahoo.com/news/key-factors-to-consider-before-jumping-into-hot-ip-os-according-to-ubs-154040686.html