Are IPOs a Good Investment? 5 Factors to Consider

IPO investing is exciting, risky, sometimes profitable, and exceeding accessible to retail investors. But IPO investing can also be frustrating and loss provoking. Weighing the pros and cons — are IPOs a good investment against the broader market and for your investment objectives?

Like all investing, you must consider IPO opportunities in the context of your broader investment objectives. If you’re reading this, let’s assume you’re considering adding IPOs to your portfolio of investment strategies but need some guidance.  

The quick answer to the title of this article is — sometimes.

Trading IPOs for short-term games can be profitable with access to high-demand deals. But trading is for traders. 

For long-term investors, IPO selectivity is crucial. Patience and abstinence may be necessary when valuations get out of hand. Since IPO stocks are new and unproven as public entities, the investment risk increases.

This article looks at 5 factors to consider when deciding if IPOs are a good investment.

5 Factors to Consider: Are IPOs a Good Investment?

IPOs are only suitable investments for some retail investors. IPO investing involves a significant risk increase compared to buying index funds, managed mutual funds, or long-established blue-chip stocks.

But investors crave alpha — returns above the broad market returns. IPOs are one way to achieve alpha. 

However, recent IPO stock prices often lag market returns due to inflated valuations upon the public offering. 

IPO companies often wait until broader valuations are inflated before conducting an IPO.

Though nimble traders may find profitable volatility in IPOs, long-term investors must scrutinize valuations more harshly to avoid overpaying. 

Consider these 5 factors when determining if IPOs are a good investment.

1. Suitability for Your Investment Objectives

IPO investing is for intermediate to advanced investors with a high risk tolerance looking to profit from either short-term IPO price increases or long-term growth. 

DIY investors looking to add IPOs to their investment strategy should ensure they first have a significant portfolio foundation of stocks, index ETFs, mutual funds, and bonds — before investing in IPOs, and only invest in IPOs with funds designated for speculation (no more than 5%-10% of your investment portfolio). 

IPO investing is a supplemental activity. 

During favorable IPO conditions, many IPOs will see a price increase on the first day of trading. 

But months or years down the line, the same IPO stocks may have different fortunes. 

Short-term traders with access to IPOs can profit from early trading volatility. This strategy only works if the shares are not restricted. 

Buy-and-hold investors can profit from innovative, newly-minted public companies over the long term.

But participation in the IPO may not be necessary as stock prices often fall below the IPO price months after the public offering. Investors must be selective and wary of inflated valuations. 

IPO stock research is similar to public stocks, but historical data is limited. IPOs require more sophisticated analysis than publicly traded stocks.

Investors must be willing to dissect S-1 filings, perform market and competitor analyses, and evaluate financials before an investment.

The IPO market is highly emotional, often trending with market sentiment. When public growth stocks are trading at inflated valuations, that tends to be a popular time for IPOs. 

If you’re looking for alpha in IPOs, deploy either a trading or buy-and-hold strategy. 

Trading is all about access and liquidity. If you have both, you may be able to secure short-term profits from immediate price spikes. 

Long-term buy-and-hold investing in IPOs is similar to investing in established public stocks.

Valuation fundamental analysis is crucial to avoid overpaying for an IPO stock.

You may be able to acquire IPO stock for cheaper before the IPO on pre-IPO investing platforms or after the public offering once valuations revert to intrinsic value. 

2. Historical Performance

IPO markets are feast or famine. When conditions are favorable, startups rush for the door. But during down market years or volatility, startups tend to avoid IPOs, waiting for more favorable market conditions. 

When IPO markets are strong, such as during the 2020-2021 IPO bonanza, IPO stocks tend to outperform the broader market. 

However, if market conditions sour and inflated valuations begin to revert, stock prices can fall significantly, as we saw in 2022. 

IPO investors have a vehicle to evaluate IPO stocks against the broader market — The U.S. Renaissance IPO ETF (symbol: IPO). 

The Renaissance IPO ETF is a transparent rules-based ETF that tracks as closely as possible, before fees and expenses, the price and yield performance of the Renaissance IPO Index. Each quarter the ETF is rebalanced as new IPOs are included, and older constituents cycle out three years after their IPO. Constituents are weighted by float-adjusted market capitalization with a cap imposed on any weightings exceeding 10%.

The IPO ETF is the best proxy available for post-IPO stocks. Launched in 2013, the fund includes stocks that conducted an IPO in the last three years that raised more than $100 million. 

It rebalances every quarter. Since the holdings are less than three years public, there is “virtually no” overlap with the S&P 500 index. 

We can use the IPO ETF to compare against the S&P 500 Market Index ETF (symbol: SPY).

The chart below is a 5-year chart comparing a $10,000 investment in both ticker symbols five years ago to today. Use your mouse to hover over the data points.

The results as of writing (February 2023) show that during the 2020-2021 period of IPO market activity, recent IPO stocks significantly outperformed the S&P 500 index. But when the broader stock market declined in 2022, IPO stocks reversed fortunes in favor of the market index. 

Though past performance is not indicative of future results, the latest data suggests that post-IPO stock performance trades with IPO market favorability.

The chart indicates that long-term buy-and-hold index investing is less volatile and has better returns than investing in IPO stocks over the past five years. 

Therefore, investors must select the right IPO stocks to succeed and not rely on an IPO index to outperform the broader markets. 

3. Your Investing Strategy and Experience Level

What is your style of investing? Are you a:

• Trader
• Stock Picker
• Indexer
• Beginner, intermediate, or expert investor?

Your broader investing strategy should match your IPO investing strategy.

Non-traders should not try to trade IPOs. 

Traders are unlikely to have the patience to be long-term buy-and-hold investors. 

A tempting middle ground is for buy-and-hold investors to try and profit from short-term volatility.

This is a gray area because making quick money in IPOs is alluring, but not knowing when to hold or sell can deteriorate returns.

If buy-and-hold investors want to dabble in short-term gains, define a clear exit price for IPO price pops and set firm lower limits on losing ventures. Share restrictions and broker penalties for “flipping” IPOs complicate matters. 

Index investors may try their hand at pre-IPOs or IPOs with funds designated for speculation to add alpha to their portfolios.

However, buying individual growth stocks may be out of their comfort zone. Index investors may only be interested if they have an investing advantage, such as unique product or company knowledge (see #5).

Beginner investors should only attempt to invest in IPOs if they have a specific connection to an IPOing company, such as through employment or as a customer (for example, Uber drivers were invited to participate in the IPO).

4. Access/Availability to IPOs

Investors can best invest in IPOs if they have early access. Early access to IPOs comes in two forms:

• Pre-IPO Access
• IPO Access via Online Brokers

Pre-IPO Access

One of the most advantageous ways to access IPOs is through pre-IPO platforms. These platforms bring liquidity to private companies allowing accredited (primarily) retail investors to acquire shares long before the IPO process begins. 

For long-term investors, it’s a way to acquire shares at a lower cost basis than waiting for the IPOs. 

Pre-IPO investing carries significant risk.

First, pre-IPO companies are not required to report financials to the public, so investors may be investing without financial information. 

Second, valuations matter in pre-IPO investing. Available shares are often listed at a premium to the previous private funding valuation. It’s easy to overpay. There may also be selling restrictions when the IPO arrives. 

Third, pre-IPO companies may not be as established as public companies and may fail or be acquired before an IPO. Acquisitions can be a profitable exit, but not all companies succeed. Investors must be choosey in their pursuit of pre-IPO shares. 

BlockFi, for example, is a cryptocurrency company previously available on pre-IPO marketplaces but has since entered bankruptcy. Pre-IPO investors who acquired shares lost everything. 

If investors can select fast-growing companies and get access to equity, there may be opportunities to profit when the IPO completes.

Some examples of pre-IPO platforms include:

• Equitybee — Provides accredited investors access to pre-IPO startups by funding employee stock options. In exchange, investors gain a portion of the future stock value.
• Fundrise Innovation Fund — A new venture capital investment fund open to non-accredited retail investors.
• $10 minimum investment.
• ARK Venture Fund — A slightly more mature venture capital fund led by Cathie Wood.
• EquityZen — One of the most active pre-IPO marketplaces.

Check out our complete list of pre-IPO investing platforms. 

Please note: This is a testimonial in partnership with Fundrise. We earn a commission from partner links on AccessIPOs.com. All opinions are my own.

IPO Access via Online Brokers

Multiple low-cost online brokers have built the infrastructure to conduct IPOs on their platforms, offering IPO shares to customers at low minimums. 

Though more IPOs are available to retail investors, quality can be dubious, requiring selectivity. 

Low-cost brokers that offer free IPO investing include:

• • Tradestation — Via the ClickIPO app. More than 300 IPO opportunities have been completed to date.
  • Robinhood — Via the IPO Access Platform. Initial IPO opportunities were unkind to investors. 
  • Webull — ClickIPO access embedded into the app. 

Buy-and-hold investors are best suited to focus on accessing IPO shares in companies they wish to own for the long term. Access to the highest-demand IPOs will be challenging unless your online brokerage acquires exclusive access to shares. 

Legacy brokers such as Fidelity and Charles Schwab have historically received allocations of high-demand IPOs. However, legacy brokers typically reserve IPO access for their wealthiest customers.

Beware — some online brokers penalize “flippers” — investors who sell shares quickly after the IPO. Penalties restrict future IPO access. 

Learn more about the best brokers for IPO investing.  

5. Investor Advantage

Many pre-IPO companies are innovative and growing but not yet well-known. 

Investors with early exposure to a company may have specific advantages over investors that do not. 

For example, engineers in cloud computing or cybersecurity may be familiar with up-and-coming software companies that are replacing legacy technologies. 

Diners in one region of the country may know of a fast-growing restaurant concept with the potential to expand across the U.S. 

Early knowledge of innovative startups can be advantageous, depending on how early you are and the broader demand for a specific company or technology. 

But be cautious. Often, investors may think they’re ahead of the game. But in reality, private companies are already well-known by investors.

For example, SpaceX is a private company worth more than $100 billion. Novice aspiring IPO investors may believe they are early to identify the company as an exciting pre-IPO opportunity. However, they are far behind, as SpaceX’s private valuation has soared and share demand is robust. An IPO would be a blockbuster. 

If your advantage is legitimate, look for pre-IPO access opportunities for early access or research how to acquire shares during the IPO. 

Conclusion — Are IPOs a Good Investment?

To answer the question “are IPOs a good investment for me” evaluate your investment objectives and how IPO investing can potentially add alpha to your returns. 

IPO investing is a supplemental activity best practiced by intermediate to advanced DIY investors. Investors should first have a foundation of index funds or individual stocks before investing in IPOs. 

Only invest in IPOs with funds designated for speculative risk because IPO investing carries a higher risk due to inflated valuation, volatility, and lack of preceding quarterly reporting. 

Traders can trade IPOs, but non-traders should use caution. Long-term buy-and-hold investors may consider sticking to that strategy when investing in IPOs.

But beware of inflated IPO valuations. If public growth stocks appear to have inflated prices, IPO stock will also. Consider investing in innovative companies after the IPO, or expect to average down if prices fall below the IPO price. 

IPO access is key to successful IPO investing. Look first to pre-IPO investing platforms for access to late-stage startups that may eventually have a public offering. Acquiring shares multiple years before the IPO can lower your cost basis and improve profits. But also be aware of trading restrictions after the IPO is complete. 

Access to IPOs via participating brokers is another way to invest. However, you must first open an account. Investors pursuing specific IPOs can monitor S-1 filings to see which brokers may receive access to IPOs.

Robinhood, and TradeStation are currently the most likely candidates for IPO access, all having share allocation capabilities built into the platforms.

Lastly, direct your IPO investing attention to areas where you may have an advantage, such as industry knowledge or as a customer of a fast-growing private company. Your early knowledge of up-and-coming companies may be an advantage. But you may be behind more sophisticated investors. 

IPO investing is a privilege. Investors are never guaranteed shares, and stocks may open below the IPO price. Occasionally, the stock price pops, and investors receive a quick win. But these opportunities are rare for individual investors.

Avoid the temptation of hot IPOs that are drastically overvalued. Wait until valuations normalize, and consider investing in select innovative companies for the long run to improve your chances of success. 

Photo credit: Emily Morter via Unsplash