When to buy into tech IPO stocks to maximize returns

2017 is set to bring a series of highly anticipated tech IPOs — when should you buy?

First things first, I’m not a stock advisor — anything that you read below are just based on my analysis of publicly available information. Personally, I invest and a significant portion of my portfolio is technology companies. I initially started doing this analysis for myself to determine the most opportune time to take a position in a tech company (on the IPO date; after the lock up period; when you feel like it; some other milestone). So all this to say, don’t sue if you invest in a company after reading this and it doesn’t work out for you — one should always do their own research before investing anyways! All data used in the analysis is publicly available information (stock prices are from Google Finance-Google Sheets integration; IPO prices, dates, lock up periods are available on www.nasdaq.com)


Background

…now that, that’s out of the way and I haven’t scared you off yet, the main question I wanted to answer (for myself) is: What is the optimal time to take a position in a technology company IPO? Now, obviously there are a lot of factors like the size of your position, how long you’ll be holding it for, what’s your risk profile, etc. Think of it is trying to figure out where along the life of a tech company between the date it IPO (t=0) to one year (t=261; yes this is the number of business days in a typical year!). You know the whole adage: “Buy low, sell high”. Is there any pattern that tech IPOs follow?

Many experts are predicting that 2017 will be a big year for tech IPOs, so I thought I’d do some analysis to be ready for an influx of freshly minted publicly-traded tech companies to invest in:

Google search: 2017 tech ipo predections

There are many factors when deciding to invest in a company that goes beyond timing (ie. when to take your first position in the stock). Every investor develops their own thesis and forms an opinion before putting their money where their mouth is.

Approach

To conduct my analysis, I looked at 35 tech companies that went public (IPO) in the last 2 years:

(Full disclosure: Box, Shopify and Square are part of my personal portfolio, if you really care about that stuff)
A very hard to read chart looking at the stock prices of all 35 companies over time

Amongst these companies I considered each stock’s return (the increase/decrease in value of the stock over time) taking into account the following:

  1. Tenure — the number of days elapsed between the date of IPO to Jan 13, 2017
  2. Lock up period — any pattern leading up to and following the 180-day period
  3. Exchange — does the stock exchange that the stock IPOs on and thus trades on, make a difference (pretty sure it doesn’t, but heck I have the data so why not take a look!)

Definitions

There are a couple of terms that I’ll use throughout (some common, some that I made up), so it’s worth summarizing here.

  • IPO Price — the price at which the company sells shares to the underwriter (an investment bank). As a retail investor (ie. like myself), I do not have access to this IPO price since this is the price at which the company sells its shares directly. A retail investor buys shares on the secondary market from other investors (not the company itself).
  • Day 1 Close Price — the stock price at the end of the first trading day of the company’s life as a publicly-traded company. This is the best proxy for the price at which a retail investor can buy their shares.
  • “The pop” — the difference between the IPO price and the Day 1 Close Price.
  • Tenure — the number of days elapsed between the date of IPO to Jan 13, 2017 (the date I looked at for conducting this analysis).
  • Lock up period — An IPO lock up period is a contractual restriction that prevents insiders who are holding a company’s stock, before it goes public, from selling the stock for a period usually lasting 90 to 180 days after the company goes public. (Thanks Investopedia!) [For the 35 companies I looked at, all had a 180 day lock up period.]

Analysis

This is probably why you ended up on this page in the first place — here we go!

Tenure

Nothing too exciting here, other than Box is the most tenured company having gone public in January 2015, while Blackline is the most recent IPO considered having gone public in October 2016. Another important note is that 18/35 companies have been around past their lock up period.

Returns vs Tenure — Any correlation?

The first thing I looked at was — is there a correlation between tenure and returns? Or said another way, do returns go up as the company gets older and has more experience as a publicly traded company? If true, then one could buy on Day 1 and over time they will make money as the company gets more tenure.

But here’s what happened…

As you can see, there isn’t any correlation between a company’s tenure as a public company to the return of that stock. Fitbit (NYSE: FIT) has been public for 398 days, but is down 75%, while Cotiviti Holdings (NYSE: COTV) is up 101% from its Day 1 Close Price after 161 as a public company.

If it wasn’t clear from the chart above, this should make it crystal clear:

This chart plots the % return from the Day 1 Close price to Jan 13, 2017 (y-axis), based on the company’s tenure (x-axis). As you can see, there’s no pattern here!

Try, drawing a line of best fit through that!

Again, other than a few outliers, there isn’t much correlation between Returns and Tenure.

Bonus Analysis — The Win-Loss Quadrant

If you’re still reading, you deserve some bonus analysis.

I thought it would be interesting to look at the Day 1 returns (ie. “The Pop”) and Returns from Day 1 Close to Jan 13, 2017.

Here’s what happened…

What do the quadrants mean?

Lose-Lose: Companies (5) in the Lose-Lose quadrant are stocks where the Day 1 Close price was lower than the IPO price AND the return from Day 1 Close till January 13, 2017 is also negative. So this means that if someone sold their shares (purchased at the IPO price) at the end of Day 1, they would have lost money. If they then turned around and purchased some shares at the lower Day 1 price (compared to IPO), they are still losing money as of Jan 13, 2017! It’s a LOSE-LOSE situation.

Lose-Win: Companies (4) in the Lose-Win quadrant declined on Day 1 (compared to their IPO price), but if someone purchased these stocks at the end of Day 1, they’re currently up (as of Jan 13, 2017). Day 1 Losers, but others are winning!

Win-Lose: Companies (15) in the Win-Lose quadrant experienced “The Pop” and shot up in value from their IPO price, but if someone bought the stock at this Day 1 Close they’re currently losing money as of Jan 13, 2017. Said another way, the stocks have not reached the returns experienced after “The Pop”, since Day 1 till Jan 13, 2017.

Win-Win: Companies (11) in the Win-Win quadrant, not only experienced “The Pop” upon IPO, but they’re stock is higher than the price it closed at on Day 1. Both the IPO investor and retail investor is making money with these companies!

Lock up Period

It’s worth discussing the implications of this milestone before diving into the analysis. One would assume that when the lock up period expires (after 180 days of a company’s IPO), there would be an influx of insiders who would take the opportunity to sell their shares. As a result of this — there would be additional supply (of shares) than demand. Basic Economics 101 would suggest that this would cause a decrease in the price per share.

An important note here is that not all companies analyzed have been public past their lock up period. For this particular analysis, only companies that have been public for 185+ were considered.

So what does the analysis say…

Other than the fact the chart is super busy, it can be seen that directionally (for the most part), a few days after the lock up period stocks are trading lower than the previous day.

This becomes evident when…

…we look at the median and mean day-to-day stock price changes.

Finally, what if we consider all these stocks (the 18 companies in the analysis) as a “basket of stocks”. That is to say, if we add the stock prices of all 18 stocks after they’ve been public for 171 days and compare that basket up to 185 days of being public, what does that look like?

The returns are indexed to day 171 — so after 171 days of being a public company, these 18 companies had a combined stock price of $294.65 and at the end of day 185, their combined stock price was 294.36 or a 0.10% decline in the collective “basket of stocks”.

Obviously this return will change based on when which day you decide to index the returns. I chose 171 since it is approximately 10 (trading) days ( or 2 weeks) prior to insiders thinking about the lock-up period. There appears to be a decline leading up to day 179, before we experience an uptick and decline again on day 181.

The punchline here is…

…there appears to some volatility leading up to and following the expiration of the lock up period. There are 2 ways to play this:

  1. If you already own shares in the company that were purchased between IPO and day 180, don’t panic leading up to the lock up period due to the declines. As can be seen, 5 days after the lock up period expires Day 185, you’re down 0.10% from the levels at Day 171 — more or less this is flat. Just ride it out!
  2. If you’re looking to take a position around the lock up period…I’d say WAIT! Here’s why — there’s a lot of volatility in the price 10 days leading up to the lock up period. Sure it seems like Day 176 is the “best” time to get into the stock it’s the furthest it falls. But it’s hard to say that all stocks would act this way (this is a sample of 18 stocks after all). Also in the grand scheme of things you’re potentially “saving” less than 3% (on $1000 investment, that’s $30!). Rather that buy during the volatility, wait for the lock up period to expire and buy into the stock 1–2 weeks after the lock up period expires. (If this doesn’t work out, don’t sue me! Remember the disclaimer at the beginning of this post!)

Exchange

Spoiler alert — the exchange that the stock IPOs on and thus is traded on has no impact on the returns.

Anyways, here are the numbers and some charts to prove this.

Both the NYSE and Nasdaq are great exchanges — and you shouldn’t make an investment decision based on which exchange the stock is traded on (all else being equal)!

Conclusions

Tenure

Tenure has no direct correlation to returns. It doesn’t matter if a company has been public for 50 days, or 150 days, there is no definite pattern to say company returns increase with tenure.

Now, this is only looking at companies that have gone public in the last 2 years. Yes, if you look at companies like Amazon (AMZN), or Apple (AAPL), or Alphabet (GOOG), who’ve been public for a lot longer they’ve all had astronomical returns since their IPO. But as a counter example, just look at Jive Software (JIVE)— they’re down 70% since their public stock debut!

Lock up period

There does appear to some volatility around the lock up period. For the most part stocks decline a few days immediately following the lock up period as insiders look to sell their shares they weren’t able to before. Days leading up to the lock up period, stocks tend to be volatile. If you own stock already, its best not to overreact during the lock up period and ride it out. If you’re looking to take a new position in the stock — wait out the lock out period volatility!

Exchange

As expected, there is no meaningful impact to returns for a stock being traded on a particular stock exchange.

Now what?

Well, we’ve accomplished a few things:

  1. Tenure broadly speaking doesn’t have much correlation to returns
  2. Avoid the volatility a few days leading up to, and following the lock up period to take a new position in the stock. And if you already own a position, just ride out the lock up volatility — don’t panic!
  3. Whether a company goes public on the NYSE or the Nasdaq shouldn’t be a factor in deciding to invest in that company.

Do your research

Prior to any company’s IPO, management will file an S-1 — this is publicly filed and available to potential investors (including retail investors!). If you’re thinking of taking a position in the company once it goes public, its best to look through the S-1 filing. Also review presentations from the roadshow and other materials from the company.

Don’t just review the company’s materials — take the time to review the industry that the company operates as well as other third-party reports.

After conducting your research form a thesis around the industry the company operates in and where you believe the company will be positioned in that industry.

Ask yourself the following (not a comprehensive list):
  • Is the company serving a market that you think is growing?
  • How has the company been growing the past few years leading up to the IPO (it’s in their S-1!)?
  • Has their growth slowed down or are they still growing at a rapid rate?

And remember — as a retail investor, you won’t have access to the IPO price. Consider cases (see quadrant above), where companies experienced “The Pop” but the returns since Day 1 close have been negative (the Win-Lose quadrant).

Some final words…

Investing is more of an art than a science — if everything was predictable and had one right answer, everyone would invest (at Day 1 close) and make money each day following.

Every investment comes with risks — it’s about doing your research so you can understand the magnitude of that risk and decide whether the upside potential (in spite of the risk) is worth your investment. As a wise man once said: “high risk, high reward”

And remember…don’t sue me if you invest in what is expected to be a busy year of tech IPOs, and it acts like a Fitbit. If it does end up being like Cotiviti or Acacia Communications — give me a shoutout!

If you want to get high quality images of these charts, or just chat about IPOs, tech, (or anything really), DM me on Twitter: @ shubham

Shubham Datta is passionate about technology, startups, sports, and investing. He is an Associate at SurePath Capital Partners, where he helps fund, grow and exit startups. He has a B.Math from the University of Waterloo and is a CPA by training. You can find out more at www.shubhamdatta.com.

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