InvestGen Archives

Dec

2024

What Are Margin Rates?

By Rebecca Lake | Growing Wealth, invest, Investing | Comments Off

A margin rate is the interest rate that applies when investors trade on margin. Margin rates can vary from one brokerage to the next, and there are different factors that affect the rates brokerages charge. Many brokerages use a tiered rate schedule based on the amount of the margin loan.

Trading on margin can increase an investor’s purchasing power and potentially, their returns. Margin trading simply means investing with money borrowed from a brokerage in order to buy more shares than you might otherwise be able. While trading on margin may benefit investors by providing them with additional capital, it can also be riskier than regular online stock trading. Before opening a margin account, it helps to understand the basic margin rate definition.

Key Points

• Margin rates represent the interest charged on borrowed funds used for trading securities and can vary between different brokerages based on several factors.

• A margin account allows investors to purchase securities with borrowed money, enabling them to increase their buying power but also introducing additional risks.

• Factors influencing margin rates include the broker call rate, demand for margin loans, inflation, and the account balance maintained by the investor.

• Margin rates accrue daily and are charged monthly, meaning that the longer an investor holds a margin loan, the more interest they will pay.

• Understanding margin rates and their implications is crucial for investors, as these rates directly impact the profitability of margin trading strategies.

Understanding Margin Rates

A margin rate is an interest rate or premium that applies to margin trading accounts with a brokerage.

It helps to start with an overview of how margin accounts work to understand margin rates. Margin accounts allow investors to purchase securities using borrowed money. Investors may use margin to trade options, individual stocks, or other securities. Under Federal Reserve Board Regulation T, brokerage firms must cap the amount investors can borrow up to 50% of the securities’ purchase price. This is called the initial margin.

Investors must also meet maintenance margin requirements in their margin account. Specifically, an investor’s equity can’t fall below 25% of the current market value of the securities held in the account.

If an investor fails to meet maintenance margin guidelines, they may be subject to a margin call. A margin call is when the brokerage requires the investor to deposit more money into their margin account in order to make additional trades.

Brokerage firms charge margin rates, the same way a bank might charge interest on a mortgage or a business loan. Interest is a form of risk management, in the event that a borrower defaults.

💡 Quick Tip: When you’re actively investing in stocks, it’s important to ask what types of fees you might have to pay. For example, brokers may charge a flat fee for trading stocks, or require some commission for every trade. Taking the time to manage investment costs can be beneficial over the long term.

How Margin Rates Work

Margin rates represent the cost of borrowing for an investor for an outstanding margin loan. Each brokerage can set the margin rate differently, it typically reflects the current broker call rate or call money rate. This is the rate that the bank charges the broker for the money used to fund investors’ margin loans.

Brokerages can establish a base rate, then add or subtract percentage points from that margin rate based on the margin balance. The higher the balance in a margin account, the lower the likely margin rate. So the more you borrow from the brokerage, the less you’ll pay in interest for it, as a percentage of the balance.

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Factors That Affect Margin Rate

There are a variety of factors that can determine what a brokerage charges for margin rates.

Broker Call Rate

This is the rate that brokerages pay to borrow the money used to fund margin loans. The higher this rate is, the higher the base margin rate may be.

Supply and Demand

Increased demand for margin loans could result in brokerages charging higher margin rates, both to manage risk on those loans and to reap higher profits.

Inflation and Monetary Policy

Margin rates reflect broader interest rates. If banks begin charging brokers higher interest rates, they’ll pass those on to investors.

Account Balance

Maintaining a higher balance on margin could result in a lower margin rate if the brokerage discounts rates for clients who invest more.

How Can Margin Rates Affect You?

Margin rates can determine your total net profit when trading securities on margin.

Assume, for example, that you open a margin account. You want to purchase $10,000 worth of securities of which $5,000 is borrowed money. You take out a margin loan to purchase the stocks. Those same stocks increase in value, so your $10,000 investment ($5,000 of your own money + $5,000 margin) is now worth $15,000.

You sell the stocks and repay the $5,000 you initially borrowed. You also pay $500 in interest to the brokerage for the margin loan. Once you subtract your initial $5,000 investment, the total net profit to you is $4,500.

Now, how do margin rates affect you if your investment doesn’t pan out? Going back to the previous example, say those stocks drop in value to $6,000 rather than increasing. You sell them for that amount, then pay back the $5,000 you borrowed on margin. You also have to pay $500 in interest. If you subtract those amounts from your initial $5,000 investment, you’re now left with only $500.

Understanding margin rates — and the risks involved in margin trading — can help you decide if it’s an investment strategy worth pursuing, based on your risk tolerance and goals.

When Is Margin Rate Charged?

Margin rates are accrued daily and charged on a monthly basis. So as soon as you purchase securities on margin, the margin rate applies and begins accruing. The total amount of margin interest paid depends on how much you borrow from the brokerage, the margin rate and how long it takes you to pay the loan back.

Generally speaking, traders use margins for short-term trading purposes. Though there’s no set end date for margin loans, the longer you take to pay them off, the more interest you’ll pay in total.

How Is Margin Rate Calculated?

Unlike other loans, margin loans typically do not have a set end date. Interest charges accrue monthly. To find the annual interest rate on a margin loan, you’d multiply the margin rate by the principal amount. To find the daily rate, you’d divide that amount by 360 days.

So assume that you have a $100,000 margin loan with a 6.825% margin rate, which is a common margin rate figure at top brokerages. Your yearly interest charges would add up to $6,825. If you divide that by 360, your daily interest charge breaks down to $18.96. If you were to pay your margin loan off in 10 days, you’d pay a total of $189.60 in interest.

Determining how much you’ll pay for a margin loan is relatively easy if you know the margin rates that apply and have an idea of how long it’ll take you to pay it back. At the very least, you can figure out the daily interest charge and use that as a guide for calculating your total profits on a margin trade.

💡 Quick Tip: Are self-directed brokerage accounts cost efficient? They can be, because they offer the convenience of being able to buy stocks online without using a traditional full-service broker (and the typical broker fees).

The Takeaway

Margin rates refer to the interest rate traders or investors pay on their margin balance – the amount of money they’ve borrowed from a broker to execute traders and buy investments. Margin rates help determine how much traders will pay to use margin, and can help inform investing decisions.

Margin trading is a more advanced investing strategy that requires some consideration of risk and an understanding of market trends. If you’re just getting started with online stock trading and investing, then you may want to get a feel for how stocks work first before opening a margin account.

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FAQ

Are margin rates yearly? Daily?

Margin rates are accrued on a daily basis, and charged by brokerages on a monthly basis. So, every day that a trader has a margin balance, they’re accruing interest in conjunction with their margin rate.

What does margin rate tell you?

The margin rate tells investors how much they’ll pay to borrow money from their brokerage if they trade on margin – or, in other words, it informs them of how much it costs to use margin.

About the author

Rebecca Lake

Rebecca Lake has been a finance writer for nearly a decade, specializing in personal finance, investing, and small business. She is a contributor at Forbes Advisor, SmartAsset, Investopedia, The Balance, MyBankTracker, MoneyRates and CreditCards.com. Read full bio.

You may also be interested in:

Margin Trading: What It Is and How It Works

Margin Account: What It Is and How It Works

What You Need to Know About Margin Balance

Photo credit: iStock/Drazen

SoFi Invest®

INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE

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Dec

2024

The Ultimate List of Financial Ratios

By Rebecca Lake | Growing Wealth, invest, Investing | Comments Off

Financial ratios are numerical calculations that illustrate the relationship between one piece or group of data and another. Business owners use financial statement ratios to performance, assess risk and guide decision-making. For investors, these calculations can provide meaningful data that reflects a company’s liquidity and financial health.

The use of financial ratios is often central to a quantitative or fundamental analysis approach, though they can also be used for technical analysis. For example, a value investor may use certain types of financial ratios to indicate whether the market has undervalued a company or how much potential its stock has for long-term price appreciation. Meanwhile, a trend trader may check key financial ratios to determine if a current pricing trend is likely to hold.

With either strategy, informed investors must understand the different kinds of commonly used financial ratios, and how to interpret them.

Key Points

• Financial ratios serve as essential tools for evaluating a company’s performance, risk, and overall financial health, assisting both business owners and investors in decision-making.

• Key financial ratios include Earnings Per Share (EPS), Price-to-Earnings (P/E), and Debt to Equity (D/E), each providing insights into profitability, valuation, and leverage.

• Liquidity ratios, such as the Current Ratio and Quick Ratio, help assess a company’s ability to meet short-term obligations, crucial for evaluating newer firms.

• Profitability ratios, including Gross Margin and Return on Assets, gauge how effectively a company generates income from its operations and assets.

• Coverage ratios, like the Debt Service Coverage Ratio and Interest Coverage Ratio, measure a company’s capacity to manage its debt obligations, providing insights into financial stability.

What Are Financial Ratios?

A financial ratio is a means of expressing the relationship between two pieces of numerical data. When discussing ratios in a business or investment setting, you’re typically talking about information that’s included in a company’s financial statements.

Recommended: How to Read Financial Statements

Financial ratios can provide insight into a company, in terms of things like valuation, revenues, and profitability. They can also aid in comparing two companies.

For example, say you’re considering investing in the tech sector, and you are evaluating two potential companies. One has a share price of $10 while the other has a share price of $55. Basing your decision solely on price alone could be a mistake if you don’t understand what’s driving share prices or how the market values each company. That’s where financial ratios become useful for understanding a company’s inner workings.

💡 Quick Tip: Did you know that opening a brokerage account typically doesn’t come with any setup costs? Often, the only requirement to open a brokerage account — aside from providing personal details — is making an initial deposit.

Key Financial Ratios

Investors tend to use some financial ratios more often or place more significance on certain ratios when evaluating business or companies. Here are some of the most important financial ratios to know.

1. Earnings Per Share (EPS)

Earnings per share or EPS measures earnings and profitability. This metric can tell you how likely a company is to generate profits for its investors. A higher EPS typically indicates better profitability, though this rule works best when making apples-to-apples comparisons for companies within the same industry.

EPS Formula:

EPS = Net profit / Number of common shares

To find net profit, you’d subtract total expenses from total revenue. (Investors might also refer to net profit as net income.)

EPS Example:

So, assume a company has a net profit of $2 million, with 12,000,000 shares outstanding. Following the EPS formula, the earnings per share works out to $0.166.

2. Price-to-Earnings (P/E)

Price-to-earnings ratio or P/E helps investors determine whether a company’s stock price is low or high compared to other companies or to its own past performance. More specifically, the price-to-earnings ratio can give you a sense of how expensive a stock is relative to its competitors, or how the stock’s price is trending over time.

P/E Formula:

P/E = Current stock price / Current earnings per share

P/E Example:

Here’s how it works: A company’s stock is trading at $50 per share. Its EPS for the past 12 months averaged $5. The price-to-earnings ratio works out to 10, meaning investors would have to spend $10 for every dollar generated in annual earnings.

3. Debt to Equity (D/E)

Debt to equity or D/E is a leverage ratio. This ratio tells investors how much debt a company has in relation to how much equity it holds.

D/E Formula:

D/E = Total liabilities / Shareholders equity

In this formula, liabilities represent money the company owes. Equity represents assets minus liabilities or the company’s book value.

D/E Example:

Say a company has $5 million in debt and $10 million in shareholder equity. Its debt-to-equity ratio would be 0.5. As a general rule, a lower debt to equity ratio is better as it means the company has fewer debt obligations.

4. Return on Equity (ROE)

Return on equity or ROE is another financial ratio that’s used to measure profitability. In simple terms, it’s used to illustrate the return on shareholder equity based on how a company spends its money.

ROE Formula:

ROE = Net income – Preferred dividends / Value of average common equity

ROE Example:

Assume a company has net income of $2 million and pays out preferred dividends of $200,000. The total value of common equity is $10 million. Using the formula, return on equity would equal 0.18 or 18%. A higher ROE means the company generates more profits.

Liquidity Ratios

Liquidity ratios can give you an idea of how easily a company can pay its debts and other liabilities. In other words, liquidity ratios indicate cash flow strength. That can be especially important when considering newer companies, which may face more significant cash flow challenges compared to established companies.

5. Current Ratio

Also known as the working-capital ratio, the current ratio tells you how likely a company is able to meet its financial obligations for the next 12 months. You might check this ratio if you’re interested in whether a company has enough assets to pay off short-term liabilities.

Formula:

Current Ratio = Current Assets / Current Liabilities

Example:

Say a company has $1 million in current assets and $500,000 in current liabilities. It has a current ratio of 2, meaning for every $1 a company has in current liabilities it has $2 in current assets.

6. Quick Ratio

The quick ratio, also called the acid-test ratio, measures liquidity based on assets and liabilities. But it deducts the value of inventory from these calculations.

Formula:

Quick Ratio = Current Assets – Inventory / Current Liabilities

Example:

Quick ratio is also useful for determining how easily a company can pay its debts. For example, say a company has current assets of $5 million, inventory of $1 million and current liabilities of $500,000. Its quick ratio would be 8, so for every $1 in liabilities the company has $8 in assets.

7. Cash Ratio

A cash ratio tells you how much cash a company has on hand, relative to its total liabilities. Essentially, it tells you how easily a company could pay its liabilities with cash.

Formula:

Cash Ratio = (Cash + Cash Equivalents) / Total Current Liabilities

Example:

A company that has $100,000 in cash and $500,000 in current liabilities would have a cash ratio of 0.2. That means it has enough cash on hand to pay 20% of its current liabilities.

8. Operating Cash Flow Ratio

Operating cash flow can tell you how much cash flow a business generates in a given time frame. This financial ratio is useful for determining how much cash a business has on hand at any given time that it can use to pay off its liabilities.

To calculate the operating cash flow ratio you’ll first need to determine its operating cash flow:

Operating Cash Flow = Net Income + Changes in Assets & Liabilities + Non-cash Expenses – Increase in Working Capital

Then, you calculate the cash flow ratio using this formula:

Formula:

Operating Cash Flow Ratio = Operating Cash Flow / Current Liabilities

Example:

For example, if a company has an operating cash flow of $1 million and current liabilities of $250,000, you could calculate that it has an operating cash flow ratio of 4, which means it has $4 in operating cash flow for every $1 of liabilities.

Solvency Ratios

Solvency ratios are financial ratios used to measure a company’s ability to pay its debts over the long term. As an investor, you might be interested in solvency ratios if you think a company may have too much debt or be a potential candidate for a bankruptcy filing. Solvency ratios can also be referred to as leverage ratios.

Debt to equity is a key financial ratio used to measure solvency, though there are other leverage ratios that are helpful as well.

9. Debt Ratio

A company’s debt ratio measures the relationship between its debts and its assets. For instance, you might use a debt ratio to gauge whether a company could pay off its debts with the assets it has currently.

Formula:

Debt Ratio = Total Liabilities / Total Assets

Example:

The lower this number is the better in terms of risk. A lower debt ratio means a company has less relative debt. So a company that has $25,000 in debt and $100,000 in assets, for example, would have a debt ratio of 0.25. Investors typically consider anything below 0.5 a lower risk.

10. Equity Ratio

Equity ratio is a measure of solvency based on assets and total equity. This ratio can tell you how much of the company is owned by investors and how much of it is leveraged by debt.

Formula:

Equity Ratio = Total Equity / Total Assets

Example:

Investors typically favor a higher equity ratio, as it means the company’s shareholders are more heavily invested and the business isn’t bogged down by debt. So, for example, a company with $200,000 in total equity and $200,000 in total assets has an equity ratio of 0.80. This tells you shareholders own 80% of the company.

💡 Quick Tip: When you’re actively investing in stocks, it’s important to ask what types of fees you might have to pay. For example, brokers may charge a flat fee for trading stocks, or require some commission for every trade. Taking the time to manage investment costs can be beneficial over the long term.

Profitability Ratios

Profitability ratios gauge a company’s ability to generate income from sales, balance sheet assets, operations and shareholder’s equity. In other words, how likely is the company to be able to turn a profit?

Return on equity is one profitability ratio investors can use. You can also try these financial ratios for estimating profitability.

11. Gross Margin Ratio

Gross margin ratio compares a company’s gross margin to its net sales. This tells you how much profit a company makes from selling its goods and services after the cost of goods sold is factored in.

Formula:

Gross Margin Ratio = Gross Margin / Net Sales

Example

A company that has a gross margin of $250,000 and $1 million in net sales has a gross margin ratio of 25%. Meanwhile, a company with a $250,000 gross margin and $2 million in net sales has a gross margin ratio of 12.5% and realizes a smaller profit percentage per sale.

12. Operating-Margin Ratio

Operating-margin ratio measures how much total revenue is composed of operating income, or how much revenue a company has after its operating costs.

Formula:

Operating Margin Ratio = Operating Income / Net Sales

Example:

A higher operating-margin ratio suggests a more financially stable company with enough operating income to cover its operating costs. For example, if operating income is $250,000 and net sales are $500,000, that means 50 cents per dollar of sales goes toward variable costs.

13. Return on Assets Ratio

Return on assets or ROA measures net income produced by a company’s total assets. This lets you see how good a company is at using its assets to generate income.

Formula:

Return on Assets = Net Income / Average Total Assets

Example:

Investors typically favor a higher ratio as it shows that the company may be better at using its assets to generate income. For example, a company that has $10 million in net income and $2 million in average total assets generates $5 in income per $1 of assets.

Efficiency Ratios

Efficiency ratios or financial activity ratios give you a sense of how thoroughly a company is using the assets and resources it has on hand. In other words, they can tell you if a company is using its assets efficiently or not.

14. Asset Turnover Ratio

Asset turnover ratio is a way to see how much sales a company can generate from its assets.

Formula:

Asset Turnover Ratio = Net Sales / Average Total Assets

A higher asset turnover ratio is typically better, as it indicates greater efficiency in terms of how assets are being used to produce sales.

Example:

Say a company has $500,000 in net sales and $50,000 in average total assets. Their asset turnover ratio is 10, meaning every dollar in assets generates $10 in sales.

15. Inventory Turnover Ratio

Inventory turnover ratio illustrates how often a company turns over its inventory. Specifically, how many times a company sells and replaces its inventory in a given time frame.

Formula:

Inventory Turnover Ratio = Cost of Goods Sold / Average Inventory

Example:

Investors use average inventory since a company’s inventory can increase or decrease throughout the year as demand ebbs and flows. As an example, if a company has a cost of goods sold equal to $1 million and average inventory of $500,000, its inventory turnover ratio is 2. That means it turns over inventory twice a year.

16. Receivables Turnover Ratio

Receivables turnover ratio measures how well companies manage their accounts receivable. Specifically, it considers how long it takes companies to collect on outstanding receivables.

Formula:

Receivables Turnover Ratio = Net Annual Credit Sales / Average Accounts Receivable

Example:

If a company has $100,000 in net annual credit sales, for example, and $15,000 in average accounts receivable its receivables turnover ratio is 6.67. The higher the number is, the better, since it indicates the business is more efficient at getting customers to pay up.

Coverage Ratios

Coverage ratios are financial ratios that measure how well a company manages its obligations to suppliers, creditors, and anyone else to whom it owes money. Lenders may use coverage ratios to determine a business’s ability to pay back the money it borrows.

17. Debt Service Coverage Ratio

Debt service coverage reflects whether a company can pay all of its debts, including interest and principal, at any given time. This ratio can offer creditors insight into a company’s cash flow and debt situation.

Formula:

Debt Service Coverage Ratio = Operating Income / Total Debt Service Costs

Example:

A ratio above 1 means the company has more than enough money to meet its debt servicing needs. A ratio equal to 1 means its operating income and debt service costs are the same. A ratio below 1 indicates that the company doesn’t have enough operating income to meet its debt service costs.

18. Interest Coverage Ratio

Interest-coverage ratio is a financial ratio that can tell you whether a company is able to pay interest on its debt obligations on time. This is also called the times earned interest ratio.

Formula:

Interest Coverage Ratio = EBIT ( Earnings Before Interest and Taxes) / Annual Interest Expense

Example:

Let’s say a company has an EBIT of $100,000. Meanwhile, annual interest expense is $25,000. That results in an interest coverage ratio of 4, which means the company has four times more earnings than interest payments.

19. Asset-Coverage Ratio

Asset-coverage ratio measures risk by determining how much of a company’s assets would need to be sold to cover its debts. This can give you an idea of a company’s financial stability overall.

Formula:

Asset Coverage Ratio = (Total Assets – Intangible Assets) – (Current Liabilities – Short-term Debt) / Total Debt

You can find all of this information on a company’s balance sheet. The rules for interpreting asset coverage ratio are similar to the ones for debt service coverage ratio.

So a ratio of 1 or higher would suggest the company has sufficient assets to cover its debts. A ratio of 1 would suggest that assets and liabilities are equal. A ratio below 1 means the company doesn’t have enough assets to cover its debts.

Market-Prospect Ratios

Market-prospect ratios make it easier to compare the stock price of a publicly traded company with other financial ratios. These ratios can help analyze trends in stock price movements over time. Earnings per share and price-to-earnings are two examples of market prospect ratios. Investors can also look to dividend payout ratios and dividend yield to judge market prospects.

20. Dividend Payout Ratio

Dividend payout ratio can tell you how much of a company’s net income it pays out to investors as dividends during a specific time period. It’s the balance between the profits passed on to shareholders as dividends and the profits the company keeps.

Formula:

Dividend Payout Ratio = Total Dividends / Net Income

Example:

A company that pays out $1 million in total dividends and has a net income of $5 million has a dividend payout ratio of 0.2. That means 20% of net income goes to shareholders.

21. Dividend Yield

Dividend yield is a financial ratio that tracks how much cash dividends are paid out to common stock shareholders, relative to the market value per share. Investors use this metric to determine how much an investment generates in dividends.

Formula:

Dividend Yield = Cash Dividends Per Share / Market Value Per Share

Example:

For example, a company that pays out $5 in cash dividends per share for shares valued at $50 each are offering investors a dividend yield of 10%.

Ratio Analysis: What Do Financial Ratios Tell You?

Financial statement ratios can be helpful when analyzing stocks. The various formulas included on this financial ratios list offer insight into a company’s profitability, cash flow, debts and assets, all of which can help you form a more complete picture of its overall health. That’s important if you tend to lean toward a fundamental analysis approach for choosing stocks.

Using financial ratios can also give you an idea of how much risk you might be taking on with a particular company, based on how well it manages its financial obligations. You can use these ratios to select companies that align with your risk tolerance and desired return profile.

The Takeaway

Learning the basics of key financial ratios can be a huge help when constructing a stock portfolio. Rather than focusing on a stock’s price, you can use financial ratios to take a closer look under the hood of a company.

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Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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Dec

2024

History of IPOs That Failed

By Rebecca Lake | Growing Wealth, invest, Investing | Comments Off

An initial public offering or IPO represents a company’s first foray into the world of publicly traded stock. While an IPO can be highly anticipated by the company, prospective investors, and the market, success isn’t guaranteed.

In some cases, an IPO flops, which can raise questions about the company’s long-term viability. While a failed IPO isn’t a guarantee that a company won’t succeed, it can make establishing a firm footing in the marketplace more challenging.

What Happens During the IPO Process?

An initial public offering, or IPO, is the first time that shares of a company are offered for sale to the public. Once an IPO occurs, company stock is listed on a stock exchange and is available for pretty much anyone to buy. That said, shares can be limited, and individual investors may face certain restrictions or availability issues when it comes to trading IPO shares.

Before the IPO, the company is considered to be private. Private companies may still have shareholders, but it’s often a relatively small circle that may include founders, early employees, or even private investors such as venture capitalists.

To have an IPO, a company must file a prospectus with the SEC. The company will use the prospectus to solicit investors, and it includes key information like the terms of the securities offered and the business’s overall financial condition.

💡 Quick Tip: IPO stocks can get a lot of media hype. But savvy investors know that where there’s buzz there can also be higher-than-warranted valuations. IPO shares might spike or plunge (or both), so investing in IPOs may not be suitable for investors with short time horizons.

Behind the Scenes of an IPO

Behind the scenes, companies typically hire investment bankers and lawyers to help them with the IPO process. The investment bankers act as underwriters, or buyers of the shares from the company before transferring them to the public market. The underwriters at the investment bank help the company determine the offering price, the number of shares that will be offered, and other relevant details.

The company will also apply to list their stock on one of the different stock exchanges, like the New York Stock Exchange or Nasdaq Stock Exchange.

What Does It Mean When an IPO Fails?

When an IPO flops, it usually means that the stock’s price dips below the initial opening price set on the first day of trading.

Trading may pick up again the next day, resulting in a jump in the share price, or it may continue to flatline — or, in a worst-case scenario, it might hit rock bottom. There are different reasons why this can happen but it is disappointing to company executives as well as investors who were banking on the IPO being a winner. Despite all the hype around IPOs in recent years, there are no guarantees.

An IPO failure can also refer to a planned IPO that gets scuttled at the last minute due to problems with the company or a lack of interest from the investor community.

Knowing about failed IPOs can be useful for investors, who may benefit from a cautionary tale or too before investing in the next “big thing.”

💡 Quick Tip: Did you know that opening a brokerage account typically doesn’t come with any setup costs? Often, the only requirement to open a brokerage account — aside from providing personal details — is making an initial deposit.

10 of the Biggest IPO Failures in History

Throughout IPO history, there are some IPOs that failed more spectacularly than others. The following list is in chronological order.

1. TheGlobe.com

TheGlobe’s IPO flop in 1998 is one of the worst of the dotcom-bubble era and in IPO history overall. The company’s stock jumped an astonishing 600% on the first day of trading, raising $27.9 million in its IPO. But less than two years later, the NYSE delisted the stock after it fell below $1 per share.

2. Pets.com

Pets.com’s IPO makes the list of worst IPOs in history largely because of how quickly the company’s downfall happened. After raising $82.5 million in its February 2000 IPO, the company filed for bankruptcy a mere nine months later.

3. Vonage

Vonage’s IPO in May 2006 was so bad that the company was eventually sued over it, and three U.S. investment banks received fines from the Financial Industry Regulatory Authority (FINRA) in connection with the IPO. After falling short of the initial $17 price point, share prices continued to tumble, eventually bottoming out in the peak of the Great Recession at under $0.50 per share.

4. Omeros

Biotech company Omeros was one of the worst IPO flops of 2009. The company saw its stock price decline 36% in the worst two weeks of trading alone. Over the years, the company’s share price has see-sawed, most recently dropping below $10 per share in October 2021 and hovering there through the beginning of 2022.

5. Etsy

Etsy ended up being one of the worst IPOs of 2015. After its stock price nearly doubled from $16 to $27 on the first day of trading, the trend began to move in the other direction with prices eventually falling below $10 per share. The stock has since rebounded, but Etsy is notable for being one of the worst-performing IPOs in recent history.

6. Uber

Uber’s IPO in May of 2019 was deemed a Wall Street flop after the company failed to meet its expected valuation of $120 billion upon its debut. While the ride-sharing company aimed for a $45 per share price at opening, it opened at $42 instead before closing down at $41 per share on the first day of trading.

7. SmileDirectClub

SmileDirectClub’s first day of trading in September 2019 ended up being one of the worst IPOs in decades. The stock was initially priced at $23 per share, opened at $20.55 per share, and continued to fall throughout the trading day, eventually ending down 27.5%.

8. Root

Root Inc., an auto insurance startup, looked promising enough when its IPO raised $724.4 million in 2020. Since then, the insuretech stock’s share price is down nearly 90% since its initial offering and the company’s valuation has been cut in half.

9. Casper Sleep Inc.

Casper Sleep’s 2020 IPO got off to a shaky start, with shares trading at $12 to start. The company revised its IPO price down from an initial target range of $17 to $19 per share. The IPO put the company’s valuation at around $470 million, well below the $1.1 billion valuation it had previously garnered through private fundraising.

10. Robinhood

Robinhood’s initial public offering in July of 2021 was deemed one of the worst IPOs ever for a company of its size, with shares falling as much as 10% within minutes of the opening of trading. The company ended its first day of trading at a $29 billion valuation, well short of the $35 billion valuation that had been expected.

How Many IPOs Fail?

Pinning down the IPO success rate can be difficult, as there’s a distinction between companies that flop at opening and stay down and those that eventually go on to be highly profitable. As such, investing in IPOs entails a certain amount of risk for investors because it’s so different from analyzing a stock that already has a history of being traded.

According to a Nasdaq analysis of companies that have gone public since the 1980s, the IPO success rate is about 20%. This means that 80% of companies that go public end up being unprofitable when they make their debut on a stock exchange.

The study also found that the majority of IPOs produce negative returns over the long-term. Specifically, two-thirds of new companies underperform the market within three years of their IPO date.

Those figures may seem discouraging but that doesn’t prevent companies from pursuing initial public offerings. In fact, 2021 was a record-breaking year for IPOs, with more than 2,000 companies raising $594 billion globally with public offerings. It’s impossible to know how many of those companies will succeed, but there are certain factors that can influence whether an IPO flops or not.

Why Do IPOs Fail?

IPO success — or failure — tends to be measured in terms of how well results align with expectations. There can be a significant departure from IPO valuations and the trading prices of a stock at listing.

Whether price variation is above or below the initial valuation can determine the success of an IPO. IPOs can also be evaluated based on the actual capital raised versus what the company anticipates raising by going public.

As to what causes some IPOs to fail while others succeed, planning or lack of it typically plays a part. Central to the IPO process is researching the market to determine how much interest and enthusiasm there is among investors for the company’s offering. IPO underwriters also research the company itself to determine how well-received the offering is likely to be.

If an IPO fails, it can often be chalked up to one or all of the following:

• The IPO’s valuation is wrong and the stock is priced too high to attract interest among investors

• The company is attempting to go public at the wrong time

• There’s an underlying issue with the company’s fundamentals or governance

In the case of WeWork, there were questions about the initial $47 billion valuation and whether it might be too high. There were also concerns about the company’s leadership, which contributed to the IPO being shelved.

But even companies with a promising IPO can later fail. And conversely, a seemingly failed IPO can turn into a success story later on, as evidenced by Facebook’s initial flop and eventual rise to become a trillion-dollar company in 2021.

The Takeaway

IPO investing holds the potential for rewards, but as the flops listed here show there are also serious risks involved with trading IPO stocks. If an IPO fails, it can often be chalked up to the IPO’s valuation being off the mark; an underlying problem with company fundamentals or leadership – or maybe the initial public offering occurs at a bad time, for one reason or another.

Whatever the situation, it’s important for individual investors to research upcoming IPOs to determine whether they make sense as part of an overall investing strategy.

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.

Invest with as little as $5 with a SoFi Active Investing account.

FAQ

What makes an IPO successful?

Successful IPOs are often associated with companies that have strong fundamentals and have managed to create significant interest among investors. These companies have IPO valuations that closely align with investor expectations and they’re entering the market at an optimal time.

What happens when an IPO fails?

If an IPO fails, that doesn’t necessarily signal the end of the company. The company may adjust its business model or expectations in order to find a path toward profitability. In a worst-case scenario, however, the company could end up closing down or filing bankruptcy.

Why does an IPO fail?

There are a number of reasons why an IPO may fail but it often comes down to lack of planning or unrealistic expectations on the part of the company executives or their underwriting team. An overvalued IPO, for example, or a company that has shaky financials, could end up underwhelming investors once trading opens.

About the author

Rebecca Lake

Explore the IPO Series:

What Is an Initial Public Offering (IPO)?

What Is the IPO Process?

What Are IPO Proceeds?

IPO vs Acquisition: Advantages and Disadvantages

How Are IPO Prices Set?

What Is an IPO Underwriter and What Do They Do?

What Is an IPO Roadshow?

How Many Companies IPO Per Year? 2023 Trends

What Is a Quiet Period?

What Is IPO Subscription Status?

Navigating the IPO Lock-up Period

What Is IPO Due Diligence?

How to Find Upcoming IPO Stocks Before Listing Day

What Is an IPO Pop?

What to Do With Company Stock If Your Company Goes Public

IPO Book-Building Process Explained

Hot Issues (IPOs): What You Need to Know

What Is Pre-IPO Placement?

Do IPOs Offer Dividends?

Testing the Waters: What It Means in an IPO

Shorting an IPO: When Can You Do It?

Guide to the Dual-Track Process for IPOs

What Is Gross Spread?

IPO Oversubscription: Definition & Examples

A Guide to Tech IPOs

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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.

Investing in an Initial Public Offering (IPO) involves substantial risk, including the risk of loss. Further, there are a variety of risk factors to consider when investing in an IPO, including but not limited to, unproven management, significant debt, and lack of operating history. For a comprehensive discussion of these risks please refer to SoFi Securities’ IPO Risk Disclosure Statement. IPOs offered through SoFi Securities are not a recommendation and investors should carefully read the offering prospectus to determine whether an offering is consistent with their investment objectives, risk tolerance, and financial situation.

New offerings generally have high demand and there are a limited number of shares available for distribution to participants. Many customers may not be allocated shares and share allocations may be significantly smaller than the shares requested in the customer’s initial offer (Indication of Interest). For SoFi’s allocation procedures please refer to IPO Allocation Procedures.

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Dec

2024

Bid and Ask Price: Definition, Example, How It Works

By Laurel Tincher | Growing Wealth, invest, Investing | Comments Off

Bid and ask are commonly used investing terms, and they refer to the best potential price at which a security on the market could be bought or sold for at any given time. In other words, the best price that buyers and sellers would potentially be willing to buy (the “bid” price) or sell (the “ask” or offer price) the asset.

It’s important for traders to understand the bid vs. ask price of a security, as well as the difference between the two, which is known as the bid-ask spread. The market price is a historical price: the price of the last trade that occurred with the security. The bid and ask prices, on the other hand, show what buyers and sellers would be willing to trade the security for now.

Key Points

• The bid price is the highest price a buyer is willing to pay for a security, reflecting market demand.

• The ask price is the lowest price a seller is willing to accept, representing market supply.

• The bid-ask spread, the difference between bid and ask prices, serves as a transaction cost and indicates market liquidity.

• Narrow bid-ask spreads suggest high liquidity and trading volume, while wider spreads indicate lower liquidity.

• Investors use the bid-ask spread to assess market sentiment and risk, with narrower spreads indicating lower risk.

What Are Bid and Ask?

If you’re new to online investing or investing in stocks, you’re probably wondering about bid vs. ask prices. Bid and ask prices show the current market supply and demand for the security. The bid price represents demand for a security; the ask price represents supply.

When an asset has high liquidity — i.e. the market has a high trading volume not dominated by selling — the bid and ask prices will be fairly close. In other words the bid-ask spread, or the difference between the bid and ask prices, will be narrow in a highly liquid market. When there’s a greater gap between demand and supply, the spread will be wider.

That’s why the bid-ask spread is often considered a gauge of liquidity.

Bid Price

The bid price is the best potential price that retail investors would be willing to pay to buy a security.

So if a trader wants to sell a security, they would want to know how much they’d be able to sell it for. They can find out the best price they could get for the security by looking at the current bid price in the market, which would show the highest potential amount they could get for it.

Ask Price

Conversely, ask price is the lowest price investors are willing to sell a security for at any given time. If a trader wants to buy a security, they want to get the lowest possible price, so they look at the ask price to find out what that is.

Bid and Ask Price Examples

Let’s imagine that an investor wants to buy Stock X at the quoted price of $75, so they plan to buy 10 shares for $750. But they end up paying $752. That’s not an error, but rather because the ask price (the selling price) is $75.20.

The current price of $75 per share is the last traded price. But prices can change quickly, and in this case the ask price was 20 cents higher. The bid or buyer’s price is almost always lower than the ask price.

Investors can use limit orders to set specific parameters around the price at which they’re willing to buy or sell a security. This can give investors some control, so they’re not simply paying the current price, which may or may not be advantageous.

Evaluating the bid-ask spread can be part of an investor’s due diligence when trying to gauge rates of return for different securities.

What the Bid-Ask Spread Signals

How far apart the ask price and bid price are can give you a sense of how the market views a particular security’s worth.

If the bid price and ask price are fairly close together, that suggests that buyers and sellers are more or less in agreement on what a security is worth. On the other hand, if there’s a wider spread between the bid and ask price, that might signal that buyers and sellers don’t necessarily agree on a security’s value.

How Are Bid and Ask Prices Determined?

Essentially it’s the supply and demand of the market that sets the bid and ask prices. And many factors can play into supply vs. demand. Because of this, investors who are interested in active investing can use the difference in price between the bid and the ask of a security to gauge what the market thinks the security is worth.

Investors and market-makers can place buy or sell orders at a price they set. These orders will be fulfilled if someone is willing to sell or buy the security at that bid or ask price. Those order placements determine the bid and ask price.

What’s the Difference Between Bid and Ask Prices?

In any market, from stocks to real estate to lemonade stands, there is almost always a difference between what someone is willing to pay for an item versus what someone wants to sell it for.

A buyer may want to buy a house for $300,000, but the seller is selling it for $325,000. An investor may want to buy a stock for $100, but the sell or ask price is $105.

That difference in price is called the spread, and when the spread is narrow it’s a lot easier to close the sale. When the spread is wider, there is a bigger gap between what the buyer thinks an item is worth vs. what the seller thinks it’s worth.

What Does It Mean When Bid and Ask Are Close?

A narrow spread, i.e. when the bid and ask price are close, means traders will be able to buy and sell the security at roughly the same price. This generally means there is a high trading volume for the security, with a lot of people willing to buy and sell because of high demand.

If demand increases for the security, the bid and ask prices will move higher, and vice versa. If there is a surge in demand, but not enough supply, that might drive the bid price up. Conversely, if supply outpaces demand, the bid price of a security could fall In either case, the spread would likely get wider when the bid or the ask prices outweighs the other.

The Bid-Ask Spread

The bid-ask spread is the gap between the two prices: the bid or buyer’s price and the ask or offer price. There are different factors that can affect a stock’s spread, including:

• Liquidity. A measure of how easily a stock or security can be bought and sold or converted to cash. The more liquid an investment is, the closer the bid and ask price may be, since the market is in agreement about what the security is worth.

• Trading volume. This means how many shares of a stock or security are traded on a given day. As with liquidity, the more trading volume a security has, the closer together the bid and ask price are likely to be.

• Volatility. A way of gauging how rapidly a stock’s price moves up or down. When there are wider swings in a stock’s price, i.e. more volatility, the bid-ask price spread can also be wider as market makers attempt to profit from the price changes.

Who Benefits From the Bid-Ask Spread?

The difference in price between the bid and the ask is where brokers and market makers make their profit.

But traders can also benefit from the bid-ask spread, if they use limit orders to get the best possible price on a desired trade, as opposed to using market orders.

How the Bid-Ask Spread Is Used

When you understand how bid-ask spread works, you can use that to invest strategically and manage the potential for risk. This means different things whether you are planning to buy, sell, or hold a stock.

If you’re selling stocks, that means getting the best bid price; when you’re buying, it means paying the best ask price. Essentially, the goal is the same as with any other investing strategy: to buy low and sell high.

Bid-Ask Spread Impact on Trading Profits

Naturally, the bid-ask spread impacts trading profits, and in fact can act almost as a hidden cost.

For example, if an investor places a market order on a stock with a bid price of $90 and an ask price of $91, they’ll get the stock at $91 per share. If the price of the stock rises 5%, so the bid price is now $94.50 and the ask price is $95.55 and the bid-ask spread is $1.05.

If the investor decides to sell the shares they bought at $91 through a market order, they will receive $94.50 per share. So their profit is $3.50 per share, even though the stock price rose by $4.55. The $1.05 gap in profit reflects the $1.05 bid-ask spread on this stock.

Wide vs Narrow Bid-Ask Spread

What is the difference between wide and narrow bid-ask spreads, and what is the significance of each? Here’s a rundown.

Narrow Bid-Ask Spreads

The bid-ask spread, often just called the spread, is tighter when a security has more liquidity, i.e. there’s higher trading volume for that stock. When you think of big companies, industry leaders, constituents of different indexes like the Dow Jones or the S&P 500, those companies may have higher volume and narrower spreads.

Wider Bid-Ask Spreads

Conversely, smaller companies or those that aren’t in demand tend to have wider spreads, reflecting a lower level of market interest. These trades tend to be more expensive, as investors must contend with lower liquidity.

Impact of the Bid-Ask Spread

The narrower the bid-ask spread, the more favorable it is for traders. If an investor wants to buy 100 shares of Stock A at $60, but shares are being offered at $60.25, that 25 cent spread may not seem like much. It would add up to $25 (100 x 0.25). But if that trader wanted to buy 500 shares or more, the cost of the spread is about $125.

The Takeaway

Bid and ask prices help traders know exactly how much they may buy and sell securities for. The bid price is the highest price a buyer is willing to pay for a security. The ask price is the lowest price a seller is willing to accept. The difference between them is the bid-ask spread, or “spread.” The spread ends up being a transaction cost, as market makers pocket the cost of the spread.

Since the bid price and the ask price are essentially a function of supply and demand in the market, investors can consider the bid-ask spread as a gauge of risk. The narrower the spread, the more aligned buyers and sellers are on the value of a certain security, and thus there’s higher volume and more liquidity — and lower risk to the investor that the stock or security might lose value (although it could, as there are no guarantees).

For a limited time, opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.

FAQ

Do I buy a stock at the bid or ask price?

You buy a stock at the ask price, that’s the lowest price the seller is willing to offer.

Is the last price the same as the market price?

The last price is the last traded price for a security, or the last price at which it closed. The market price is the best current price.

Is it better if your bid is higher than the asking price?

The bid price is typically lower than the seller’s price or ask price, so it would be unusual if the bid was higher than the ask. If a bid price is higher than the ask, a trade would occur, but it would put the buyer at risk of a potential loss.

Photo credit: iStock/eclipse_images

SoFi Invest®

INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE

SOIN-Q424-021

Dec

2024

What Is a Shareholder Activist?

By Michael Flannelly | Growing Wealth, invest, Investing | Comments Off

A shareholder activist may be a hedge fund, institutional investor, or wealthy individual who uses an ownership stake in a company to influence corporate decision-making. Shareholder activists, sometimes called activist investors, typically seek to change how a company is run to improve its financial performance. However, they may also have other objectives, such as increasing transparency or promoting social responsibility.

Activist shareholders can impact the way a company is managed, thus affecting its stock price. As such, you may benefit from understanding shareholder activism and how these investors may impact the stocks in your portfolio.

Key Points

• Shareholder activists use ownership stakes to influence corporate decisions, aiming to improve financial performance or promote transparency and social responsibility.

• Activists can be hedge funds, institutional investors, or wealthy individuals seeking changes in company management.

• Activist investors may use media and shareholder voting to gain support for their proposals and influence company strategies.

• Goals of activism vary, from improving environmental impact to unlocking shareholder value through strategic changes.

• Activism can lead to stock volatility, but targeted stocks may still be valuable for diversified portfolios if proposed changes are supported.

How Shareholder Activism Works

Shareholder activism is a process in which investors purchase a significant stake in a company to influence the management of the company. When an investor builds up a large enough stake in a company, this usually opens up channels where they may discuss business proposals directly with management.

Activist investors may also use the shareholder voting process to wield influence over a company if they believe it is mismanaged. This more aggressive tactic may allow activist shareholders to nominate their preferred candidates for the board of directors or have a say on a company’s management decisions.

Activist investors typically own a relatively small percentage of shares in a company, perhaps less than 10% of a firm’s outstanding stock, so they may need to convince other shareholders to support their proposals. They often use the media to generate support for their campaigns.

Shareholder activists may also threaten lawsuits if they do not get their way, claiming that the company and its board of directors are not fulfilling their fiduciary duties to shareholders.

Activist investors’ goals can vary. Some investors may want to see companies improve their environmental and social impact, so they will suggest that the company adopt a Corporate Social Responsibility framework. Other investors try to get the company to adopt changes to unlock shareholder value, like selling a part of the company or increasing dividend payouts.

However, shareholder activism can also be a source of conflict between shareholders and management. Some activist investors may prefer the company unlock short-term gains that benefit shareholders, perhaps at the expense of long-term business operations. These investors may exit a position in a company once they unlock the short-term gains with little concern for the company’s future prospects.

Types of Shareholder Activists

There are three primary types of shareholder activists: hedge funds, institutional investors, and individual investors. So, your average investor who may be doing a bit of online investing or building a retirement portfolio likely wouldn’t qualify as a shareholder activist. Each type of shareholder activist has its distinct objectives and strategies.

Hedge Funds

Hedge funds are private investment vehicles usually only available to wealthy individuals who make more than $200,000 annually or have a net worth over $1 million. These funds often take a more aggressive approach to shareholder activism, like public campaigns and proxy battles, to force a company to take specific actions to generate a short-term return on its investment.

Institutional Investors

Institutional investors are typically large pension funds, endowments, and mutual funds that invest in publicly-traded companies for the long term. These investors often use their voting power to influence a company’s strategy or management to improve their investment’s financial performance.

Individual Investors

Though less common than hedge funds and institutional investors, very wealthy individual investors sometimes use their own money to buy shares in a company and then push for change.

Examples of Shareholder Activists

Shareholder activism became a popular strategy in the 1970s and 1980s, when many investors – called “corporate raiders” – used their power to push for changes in a company’s management. Shareholder activism has evolved since this period, but there are still several examples of activist investors

For example, Carl Icahn is one of the most well-known shareholder activists who made a name for himself as a corporate raider in the 1980s. He was involved in hostile takeover bids for companies such as TWA and Texaco during the decade.

Since then, Icahn has been known for taking large stakes in companies and pushing for changes, such as spin-offs, stock buybacks, and management changes. More recently, Icahn spearheaded a push in early 2022 to nominate two new directors to the board of McDonald’s. His goal was to get McDonald’s to change its treatment of pigs. However, his preferred nominees failed to get elected to the board.

Another well known activist investor is Bill Ackman, the founder and CEO of Pershing Square Capital Management, a hedge fund specializing in activist investing. Ackman is known for his high-profile campaigns, including his battle with Herbalife.

In 2012, Ackman shorted the stock of Herbalife, betting the company would collapse. He accused Herbalife of being a pyramid scheme and called for a government investigation. Herbalife denied the allegations, and the stock continued to rise. Ackman eventually closed out his position at a loss.

Other examples of shareholder activists include Greenlight Capital, led by David Einhorn, and Third Point, a hedge fund founded by Dan Loeb.

In 2013, Einhorn took a stake in Apple and pushed for the company to return more cash to shareholders through share repurchases and dividends. Apple eventually heeded his advice and initiated a plan to return $100 billion to shareholders through dividends and buybacks.

In 2011, Loeb’s hedge fund took a stake in Yahoo and pushed for the company to fire its CEO, Scott Thompson. Thompson eventually resigned, and Yahoo appointed Loeb to its board of directors. More recently, in 2022, Loeb took a significant stake in Disney and started a pressure campaign calling on the company to spin-off or sell ESPN. However, he eventually backed off that suggestion.

Is Shareholder Activism Good for Individual Investors?

Depending on the circumstances, a shareholder activist campaign may be good for investors. Some proponents argue that shareholder activism can improve corporate governance, promote ESG investing, and lead to better long-term returns for investors.

Others contend that activist investors are primarily interested in short-term gains and may not always have the best interests of all shareholders in mind. While individual investors may benefit from a stock’s short-term spike after an activist shareholder’s campaign, this rally may not last for investors interested in long-term gains.

The Takeaway

Shareholder activists use their financial power to try to influence the management of publicly traded companies. Because activist investors often leverage the media to promote their goals, individual investors may read about these campaigns and worry about how they could affect their holdings.

Generally, the impact of shareholder activism on investors depends on the specific goals of the activist and the response of the company’s management. If an activist successfully pressures management to make changes that improve the company’s performance, this can increase shareholder value. However, if an activist’s campaign is unsuccessful or the company’s management resists the activist’s demands, this can lead to a decline in the stock price.

For a limited time, opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.

Photo credit: iStock/xavierarnau

SoFi Invest®

INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE

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