Why it might not be smart to buy a company on its IPO day

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They say that patience is a virtue. And that’s especially true with newly public stocks.

It may seem tempting to buy Uber (UBER) on Friday — the day of its eagerly anticipated initial public offering. But take one look at Uber rival Lyft (LYFT) and you’ll see why that may not be a great idea.

Lyft is now trading about 25% below its IPO price because of concerns about how much money it is losing, competition with Uber and underwhelming results in its first earnings report since going public.

Average investors should watch and wait when it comes to a buzzy IPO instead of diving on the first few days, recommends Jim Price, lecturer and entrepreneur in residence at the University of Michigan Ross’ Zell Lurie Institute.

“Stay on the sidelines. These super hot IPOs are institutional investor plays,” Price says, referring to the large mutual funds and hedge funds that are able to buy in to an IPO at the offering price.

Mom-and-pop investors typically have to wait for a stock to start trading before they can buy — and they often wind up doing so at a big premium to the offering price.

Beware the flip

Plant-based burger company Beyond Meat (BYND) priced its IPO at $25 last week but the stock opened at $46 and went as high as $85 a few days later before pulling back to about $68.

“The big institutions pocket all the money on the first few days of trading and they know the exact moment when to trigger a flip and sell,” Price said. “Where does that leave individual investors? Not in a very good place.”

Price notes that there’s another reason to be patient with an IPO: Some investors are prohibited from selling in the first few months that a stock trades because of a so-called lockup period.

But once company founders and early-stage venture capital firms are legally allowed to sell, they may unload some shares. That could push the stock lower since there will be a bigger supply of shares on the market.

“Allowing the dust to settle — maybe a couple to six months — makes sense,” Price said.

Another problem with many IPOs — and Uber especially: It, like Lyft, is bleeding red ink.

Focus on earnings — not sales

Many startups are willing to spend a lot of money to gain market share. That may help them attract more VC money and help push their private market valuations higher.

But Wall Street investors are less tolerant of big losses. They want to see solid earnings every quarter.

Companies like Google (GOOGL) and Facebook (FB) have largely been able to do that since their IPOs. But other high-profile startups that have gone public in the past decade like Twitter (TWTR), Snap (SNAP) and Blue Apron (APRN)? Not so much.

“Ultimately, the success of both the Lyft and Uber IPOs will be judged based on post-IPO performance and how these companies can sustain their growth while moving toward profitability and lowering their cash burn,” said Alex Castelli, a managing partner at advisory and tax firm CohnReznick.

In other words, some companies may be going public simply to cash in and not because they need the money or actually have a viable long-term plan. And those are the ones that investors should view very cautiously.

“There’s an old-school business saying. Revenue is for vanity and profit is for sanity,” said Jessica Rovello, CEO & co-founder of Arkadium, a gaming and interactive media firm. She said going public isn’t in the cards for her. She’s happy staying private.

What’s the best way to invest for the long haul? Are bonds better than stocks? Do you have questions about how to build wealth? Ask us here and you may be included in a future column.

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