An IPO pop occurs after a company goes public, when its stock price jumps higher on the first day of trading.
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 of course hope to see some increase in price, a big spike — or IPO pop — could indicate that the underwriters underpriced the IPO.
Key Points
• An IPO pop occurs when a company’s stock spikes on its first day of trading and may indicate that underwriters didn’t properly price retail investor demand into the IPO price.
• In 2021, IPOs saw increases of 40% on average on the first trading day, but in the second quarter, companies were pricing below their expected ranges.
• Direct listings are an alternative to IPOs that may help avoid an IPO pop, but they aren’t as efficient at raising capital.
• Buying IPO stocks can be profitable, but it’s important to research the company before investing and to consider broad market trends.
• IPO pops are relatively common, and larger companies tend to have larger pops since they are in high demand.
IPO Pop Defined
An IPO pop occurs when a company’s stock spikes 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 increase. But if the stock jumped to $60, both the company and its early investors might believe an error occurred in the IPO pricing.
This is one of the reasons that IPO shares are considered highly risky. In many cases, historically, that initial price jump hasn’t lasted, and investors who bought on the way up have taken a hit on the way down.
Recommended: What Is an IPO?
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Problems Indicated by an IPO Pop
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 public thinks a company’s shares are more valuable than what 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 — while company founders and VCs miss out on more profits.
If the share price soars on the first day, some 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.
💡 Quick Tip: Before opening an investment account, know your investment objectives, time horizon, and risk tolerance. These fundamentals will help keep your strategy on track and with the aim of meeting your goals.
IPO Trends
In the past, some companies have seen significant IPO pops occur on their first trading day. But in many cases the market cooled down after the first quarter, with some high-profile companies seeing declines on their first day.
Take 2021 as an example; in that year there were a record number of IPOs in the market.
In the first quarter of 2021 many companies were 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% 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. This type of volatility is common to IPOs, and another reason why investors should be cautious when investing in them.
There was also a boom in special-purpose acquisition corporations (SPACs), IPOs of shell companies that go public with the sole purpose of acquiring other companies.
💡 Quick Tip: Access to IPO shares before they trade on public exchanges has usually been available only to large institutional investors. That’s changing now, and some brokerages offer pre-listing IPO investing to qualified investors.
Direct Listings
Some companies have turned to direct listings as a way to try to 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.
It’s also important to be patient and flexible, as individual investors don’t always have the ability to trade IPO shares. Or investors may have access at some point after the actual IPO. In addition, IPO shares can be limited.
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.
The Takeaway
As exciting as an IPO pop can be, it’s another example of how hard it is for individual investors to time the market. First, there’s no way to predict if a newly minted stock will have a spike after the IPO. Sometimes there is a pop and then the price plunges. This is one reason why IPOs are considered high-risk events.
Investors who find IPOs compelling may want to assess company fundamentals and other market conditions before investing in IPO stock.
Whether you’re curious about exploring IPOs, or interested in traditional stocks and exchange-traded funds (ETFs), you can get started by opening an account on the SoFi Invest® brokerage platform. On SoFi Invest, eligible SoFi members have the opportunity to trade IPO shares, and there are no account minimums for those with an Active Investing account. As with any investment, it's wise to consider your overall portfolio goals in order to assess whether IPO investing is right for you, given the risks of volatility and loss.
Photo credit: iStock/Olemedia
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