IPO Fever Is Back
The risks and rewards. Plus: are we in a bubble?
This past Friday, SpaceX became the largest IPO in history (ticker symbol: SPCX), with a launch price of $135 per share, which then ballooned to $150 per share at the immediate market open. The intraday price peaked at $176.52 just after 1:00 p.m. before settling back to end the day at $160.95.
That first-day ride alone underscores one of the risks inherent to the retail investor when investing in Initial Public Offerings. There were so many orders for SPCX queued up that many buy orders did not actually get filled until later in the day. Very few ordinary investors were able to get access to SPCX at $150, let alone $135. Instead, many of the buy orders were executed north of $170 several hours after the stock market opened. The headlines will say SPCX rose 19% on its first day of trading. In reality, however, if your order didn’t get filled until 1:00 p.m. and you held until the end of the day, you ended up down 8.5%.
There is understandably a lot of excitement about investing in IPOs. Companies that are going public are often ones with fascinating stories, compelling products, futuristic ideas, and either proven or expected future revenues that investors want a piece of. But is investing in IPOs on the first day of trading or even in the subsequent days and weeks that follow a good idea?
We’ll look at what history tells us, but first, a quick primer on how some investors gain access to IPO shares before the rest of us:
To Be An Insider
Most IPO shares are not initially distributed to ordinary investors. Instead, the investment banks underwriting the offering allocate shares to large institutional investors such as mutual funds, pension funds, hedge funds, insurance companies, and other major financial firms. These institutions often receive shares at or near the IPO price before public trading begins.
A smaller portion of shares may be allocated to wealthy clients of brokerage firms (which is actually pretty unfair, when you think about it). Company insiders, employees, venture capital firms, and early investors who backed the company before it went public also often have special access, sometimes through employee compensation plans that provided pre-public shares of the company to key individuals.
Some brokerages do offer IPO access to retail investors, but in highly anticipated offerings demand often far exceeds supply. In practical terms, many investors who want shares at the IPO price simply cannot get them. This creates an interesting dynamic, as was the case with SPCX as noted above. By the time public trading begins, much of the initial allocation has already been spoken for. The first day of trading becomes a battle between eager buyers trying to establish positions and a relatively small number of shareholders willing to sell (although as the share prices rockets upward, more sellers are brought into the market in order to try to lock in gains, often realizing the financial windfall of a lifetime in the process).
For the retail investor, the primary way to buy shares directly in a newly offered stock is simply to place an order through a brokerage account at Vanguard, Fidelity, or another brokerage firm and hope it gets filled. It might seem strange that an investor could place a trade when the market opens at 9:30 a.m. and not have it filled until hours later, but a stock trade is exactly that…a trade. For a buy order to be fulfilled, someone on the other side of the transaction must be willing to sell. In the immediate aftermath of most IPOs, there are very few sellers and countless buyers. As a result, it can take hours for all of those buyers to find willing sellers.
What History Tells Us About IPO Investing
That investing in compelling companies can make financial sense is self-evident. Virtually every publicly traded company was an IPO at one point (other than ones that were spun off from an existing customer with shares placed into trading without a typical IPO). Amazon, for example, went public in 1997 at $18 per share and finished its first day at $23.50, a gain of 31%. The stock traded as high as $29.75 during that first day, by the way, illustrating an intraday trajectory somewhat similar to that of SPCX (i.e. a sharp rise followed by the air coming out of the balloon in the latter hours of the day). Whether SPCX has a long-term trajectory similar to AMZN remains to be seen. If you had somehow been able to invest $10,000 in AMZN at the IPO price, it would be worth over $30 million today (!!!).
History, however, provides mixed evidence when it comes to investing in IPOs. Some became legendary success stories, like the clear case of AMZN. But other high-profile IPOs have had rockier starts. Facebook, for example, went public in 2012 amid tremendous excitement. Shares were priced at $38 and briefly traded above that level on opening day. Within four months, however, the stock had fallen below $18 as investors questioned the company’s ability to monetize its users. Those who declared the IPO a failure were eventually proven wrong as the company has since become one of the most valuable in the world, but it required patience as early investors took losses on paper in the early months of public trading.
The lesson is that a great company does not always make a great short-term investment. IPO investors are often paying not only for current results but also for years or even decades of expected future growth. When those expectations become too optimistic, even outstanding businesses can produce disappointing investment returns, which a lot of retail investors learn the hard way.
There are plenty of examples of IPOs that have failed. Pets.com is the classic example, having gone public in February 2000; just 268 days later, the company went out of business and investors had lost nearly everything. In 2021, Rivian went public, which was understood to be a hot new electric vehicle start-up. Shares have lost about 90% of their value since. It’s fair to say that SpaceX is not Pets.com, nor will two upcoming highly anticipated IPOs that should launch later this year: Anthropic and OpenAI, which are both slated to go public before the end of the year.
The Other Way Americans Get In On IPOs
There is another way ordinary investors participate in IPOs, often without even realizing it: through index funds.
When a newly public company eventually becomes large enough to qualify for inclusion in indexes such as the S&P 500 or Nasdaq 100, the index funds tracking those benchmarks are effectively required to buy shares. Millions of Americans therefore gain exposure to these companies automatically through their retirement accounts and investment portfolios.
This also creates a risk that many ordinary investors are probably not thinking of. While index funds remain one of the most effective long-term investment vehicles ever created, many major indexes have become increasingly concentrated in a relatively small number of large technology companies. Investors often believe they are broadly diversified when, in reality, a substantial portion of their portfolio may be riding on the fortunes of a handful of AI, technology, and communications firms. In the S&P 500, for example, the ten largest companies make up a weighted percentage of about 40% of the overall index. Since these stocks are typically highly correlated, high-tech companies, if they start to drop, it will disproportionately bring down the entire index and, with it, trillions of dollars in low-cost index funds. I wrote about this last October, saying:
If you have a 401(k), IRA, or index fund, you are likely (whether you realize it or not) participating in the AI boom. That’s not necessarily bad; innovation and long-term growth are the bedrock of markets. But it does mean you should be prepared for volatility. When a small group of stocks drives most of the market’s gains, the same dynamic can magnify losses when sentiment shifts.
That does not mean a collapse is imminent. But investors during the Dot-Com Bubble of the late 1990s learned that concentration risk can lurk beneath the surface of an otherwise diversified portfolio. If enthusiasm surrounding AI and other emerging technologies cools, many investors may discover they had more exposure to those sectors than they realized.
Are We in a Bubble?
We are nearly 2,000 words into this article, and I haven’t addressed one obvious question: What is SPCX actually worth? At Friday’s closing price, SPCX carried a market capitalization of approximately $2.1 trillion. That instantly made it the seventh-largest publicly traded company in the world. (Trivia question: Can you name the six larger companies? Answer at the end of the article.)
By traditional valuation measures, SPCX is difficult to justify. Investors are assigning an enormous value not only to the company’s current operations but also to its future potential. Most valuation models are built around present earnings, cash flow, and revenues. Judged solely by those metrics, SPCX appears extraordinarily expensive. Yet investors are not buying SPCX based on what it earned last year. They are buying it based on what they believe it might become.
Bulls argue that SpaceX is not merely a rocket company. They see it as the dominant provider of global satellite internet through Starlink, a critical player in defense and communications infrastructure, and perhaps eventually the transportation backbone for industries that do not yet fully exist. Supporters see a company whose future opportunities cannot be measured using traditional metrics. Skeptics see a company priced far beyond its current fundamentals.
The honest answer to the question of whether we are in a bubble is that no one truly knows. Bubbles are easy to identify after they burst and remarkably difficult to identify while they are inflating. In 1999, many investors recognized that technology stocks had become detached from reality, but few accurately predicted when the party would end. Likewise, many investors correctly identified the housing bubble before 2008 yet still struggled to profit from that insight because markets remained irrational longer than expected.
There are certainly signs of exuberance today. Valuations are elevated. Money for deals is flowing. Companies connected to AI are attracting enormous amounts of investor interest. Those conditions often accompany speculative periods.
At the same time, genuine technological revolutions do occur. The internet changed the world. Smartphones changed the world. AI is doing the same. The challenge for investors is distinguishing between revolutionary technologies and the excessive valuations that sometimes accompany them. Both can be true at the same time.
For ordinary investors, the broader lesson may be simpler. IPOs are exciting. They generate headlines, create overnight millionaires, and offer the allure of getting in on the ground floor of the next great company. But history suggests that excitement and investment success are not always the same thing. The simple fact of so many high-profile tech-based IPOs taking place in the same year is itself a sign of frothy, frenzied times, but then again, we do live in interesting times. More to come in the weeks ahead.
Trivia Answer: The six publicly traded companies larger (at the moment) than SPCX are Microsoft, NVIDIA, Apple, Amazon, Google/Alphabet, and Facebook/Meta Platforms.
Ben Sprague lives and works in Bangor, Maine as a Senior V.P./Commercial Lending Officer for Damariscotta-based First National Bank. He previously worked as an investment advisor and graduated from Harvard University in 2006. Ben can be reached at ben.sprague@thefirst.com or bsprague1@gmail.com. Thoughts and opinions here do not represent First National Bank.