The market for initial public offerings may be on fire this year, but investors still need to be wary of getting burned.
Many of the IPOs in 2020 are now trading above their debut price. Already, 111 companies have raised $37.8 billion, according to Renaissance Capital, which advises investors on IPOs.
However, that doesn't mean every new publicly traded company will have the same results. And financial advisors say it's best to approach any IPO with a dose of caution.
"With an IPO, you never know which way things are going to go, regardless of how much hype there is about any company going public," said certified financial planner Doug Boneparth, president of Bone Fide Wealth in New York.
IPOs are a way for privately owned companies to raise money by selling shares to the public. Before a new stock reaches the market, investment banks, which underwrite the IPO, sell shares.
Typically, those pre-IPO shares are reserved for sophisticated investors or institutions with access to such deals. Those buyers may be required to hold onto the stock for a certain length of time — six months, often — before they can sell it.
Retail investors usually have to wait for trading to start through a market like the New York Stock Exchange or Nasdaq.
"If there's huge demand for the debuting company, you'll see the stock price pop right after opening," Boneparth said.
On the other hand, he said, if there's a lack of demand or the markets think the stock is overvalued, the share price could fall. That doesn't mean it won't go back up again, but you could be waiting a while.
For example, Facebook — which now trades above $300 — debuted in May 2012 at $38 share. By August of that year, it had dropped to about $18. It took another year for it to even climb back up to its initial price.
It's important to do your research on a company before blindly jumping in just because it's a newly listed stock, Boneparth said. That includes checking out its S-1 filing with the Securities and Exchange Commission to scrutinize its balance sheet and find out the potential risks of investing in the stock. (SEC Form S-1 is the initial registration form for new securities required by the SEC for public companies that are based in the U.S.)
"If you've done your due diligence, the company has strong fundamentals and you believe in the company for the long-term, then it can be good to get in early," Boneparth said. "The price might be much lower today than years down the road.
"Just don't buy hype," he said. "You're buying a company."