No matter how much preparation they’ve done, company executives and shareholders never really know how a stock will perform once it hits the market through its initial public offering (IPO). While they may want to see some increase in price, a big spike–or IPO pop–could indicate that the underwriters underpriced the IPO.
IPO Pop Defined
An IPO pop occurs when a company’s stock price jumps higher on its first day of trading. An IPO pop may be a sign that underwriters did not properly price retail investor demand into the IPO price.
For instance, if a company prices its shares at $47 in its IPO and the price goes to $48 or $50, that would be considered a normal and positive IPO pop. But if the stock jumped to $60, both the company and its early private investors might believe an error occurred in the IPO pricing.
Recommended: What Is An IPO?
Problems Indicated by an IPO Pop
If the public thinks a company’s shares are more valuable than early investors, underwriters, and executives thought, that means the company could have raised more money, increasing their own profit. Or they could have raised the same amount of money but with less dilution. Also, when bankers price an IPO too low, that means their customers benefit and company founders and VCs miss out on more profits.
Many different factors go into pricing an IPO, including revenue, private investment amounts, public and institutional interest in investing. IPO underwriters try to find a share price that institutional investors will buy.
If the share price increases on the first day, those investors will be happy, but it means the company could have raised more money if they had priced the stock higher from the start. It also means that existing investors could have given up a smaller percentage of their ownership for the same price.
In recent years, more companies have seen significant IPO pops occur on their first trading day. In early 2021, several big IPOs had pops, which created more public interest in IPOs, further driving up stock volume. But the market cooled down after the first quarter with some high-profile companies seeing declines on their first day and fewer pops.
In the first quarter of 2021 many companies were also pricing their IPOs at the top of their expected range, due to increased demand, an improving economy, and a strong stock market. Even after that IPOs still saw increases of 40 percent on average on the first trading day.
But in the second quarter, companies were pricing below their expected ranges and some weren’t even reaching those prices on the first trading day. This made the public less eager to buy into IPOs.
Still, there were a record number of IPOs that hit the market in both 2020 and in 2021. There was also a boom in special-purpose acquisition corporations, IPOs of shell companies that go public with the sole purpose of acquiring other companies.
In response, some companies today have turned to direct listings as a way to try and avoid an IPO pop. In a direct listing, the company doesn’t have an IPO, they just list their stock and it starts trading in the market. There is a reference price set by a market maker for the stock in a direct listing, but it isn’t nearly as important as the price of a stock in an IPO. Although this can help avoid an IPO pop, it is not as efficient as an IPO as a means of raising capital.
Setting a price for an IPO is a key part of that fundraising strategy. A newer strategy companies are trying is raising a large amount of private capital just before going public, and then doing a direct listing instead of an IPO. The process gives a valuation to the stock price but in a different way from pricing shares for an IPO.
A third strategy is to direct list and then do a fundraising round some time after the listing, giving the public a chance to establish the market price for the stock.
Do IPOs Usually Go Up or Down?
Although stocks increase an average of 18.4% on their first day of trading, 31% of IPOs decrease when they start to trade. Calculations of IPO profits show that almost 50% of IPOs decrease from their day-one trading price on their second day of trading. While IPO investing may seem like a great investment opportunity, IPOs remain a risky and unpredictable asset class.
Average IPO First Day Return
IPO pops are relatively common. Sometimes average first day returns increase significantly, such as during the dot-com bubble when the average pop was 60%. Larger companies generally have larger pops, since they are in high demand.
Determining the Right IPOs to Invest In
Buying IPO stocks can be profitable, but it also has risks. Just because a company is well known or there is a lot of publicity around its IPO doesn’t mean the IPO will be profitable. As with any investment, it’s important to research the market and each company before deciding to invest.
If you’re interested in upcoming IPOs, it’s important to keep in mind that IPOs increase in price on the first day but quickly decrease again, and almost a third of IPOs decrease on their first listing day. Popular IPOs are more likely to increase, but they are also crowded with investors, so investors might not see their orders fulfilled.
When investing in IPOs through your brokerage account, it’s important to look at broad market trends in addition to individual company fundamentals. When the market is strong, IPOs tend to perform better. Also, when high-profile companies have unsuccessful IPOs, investors may become more wary about investing in upcoming IPOs.
Each sector has different trends and averages. Generally tech companies have higher first day returns than other types of companies, even though they’re also often unprofitable. Investors still want in on these IPOs because they may have strong future earnings potential.
Historically, some of the most successful tech stocks started out with negative earnings, so low earnings are not a strong indicator of future success or failure.
Investing in IPOs can be very exciting and profitable. For retail investors, an IPO pop is a good sign, since it means their investment could go up in value, and they do not have to worry about the value of their pre-IPO shares.
If you’re interested in getting started with investing in IPOs, one great way to get started is by opening an online brokerage account on the SoFi Invest® brokerage platform. It lets you research, track, buy, and sell the latest upcoming IPO stocks, even if you only have a few dollars to invest.
Photo credit: iStock/Olemedia
The information provided is not meant to provide investment or financial advice. Also, past performance is no guarantee of future results.
Investment decisions should be based on an individual’s specific financial needs, goals, and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
1) Automated Investing—The Automated Investing platform is owned by SoFi Wealth LLC, an SEC registered investment advisor (“Sofi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (“Sofi Securities).
2) Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.
3) Cryptocurrency is offered by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business.
For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, please visit www.sofi.com/legal. Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform. Information related to lending products contained herein should not be construed as an offer or prequalification for any loan product offered by SoFi Bank, N.A.