No, you shouldn’t.
Unlike a lot of financial planners out there, I love to invest in individual stocks. I typically include some individual stocks in a portion of my clients’ portfolios, in addition to widely diversified, low-cost ETFs or index funds.
But that being said, you need a strategy for choosing which stocks to buy. And quite frankly, IPO stocks should rarely, if ever, fit that strategy.
[Note: this post was originally published a few days prior to Snapchat’s IPO in March 2017. While this particular article discusses Snapchat in particular, most of the commentary in this article can apply to any IPO.]
What is an IPO?
IPO stands for Initial Public Offering. In other words, a stock’s IPO is the process by which the company issues its first shares of stock to the public.
The stock in question- Snapchat- has their IPO set for Thursday, March 2. In other words, starting on 3/2, you’ll be able to own shares of Snapchat stock. The starting share price is expected to be $17 per share. However, this IPO price is only good for the second the stock launches. After that, it will trade based on the supply and demand of the stock market. And be warned- typically, prices can be very volatile immediately after an IPO.
Up until this point, Snapchat was a private company. But now, if you buy shares of Snapchat stock (the stock ticker symbol is “SNAP”), you’ll be able to participate in their future growth.
If the value of the company continues to grow over time, you’ll be able to earn money based on the growth if you buy some of the stock. On the other hand, if the company struggles, you could end up losing money.
Investing in IPOs Has a Mixed Track Record- At Best
So, why shouldn’t you buy SNAP shares on Thursday (March 2)? I’m not a big believer in speculating what’s going to happen in the stock market. There’s certainly a decent chance that Snapchat will grow quickly in the next few years. But, historically speaking, IPOs tend to have a poor track record.
Take a look at the historical stock prices of a few big companies that had highly publicized IPOs in the few years following their debut: Facebook, Twitter, Visa, Alibaba, and Groupon:
Notice a trend here?
Some of these stocks have done incredibly well over a long time period- Facebook and Visa in particular. But on the other hand, Groupon is still struggling today- as of this writing, its current price is 84 percent lower than the trading price immediately after it went public.
In the short term, IPOs tend to be very volatile in price. More often than not, the market views the stock as overvalued when it is initially launched. For this reason alone, I don’t recommend buying shares of just about anything the day it’s released. Snapchat included.
Of course, past market performance doesn’t necessarily reflect what will happen in the future. And even people who bought Facebook when it debuted, and held it through today, have done very well. But frankly, this misses the broader point. I view investing in stocks like SNAP as a gamble- it could pay off, or you might lose big. I prefer an alternative method to gambling in the stock market…
You Need an Investing Strategy and Methodology
I don’t recommend that you invest in companies by chasing the proverbial shiny object. Instead, set some investing goals for yourself, and use a methodology to help guide your investments to meet these goals.
What are you trying to accomplish with your investments? How much risk are you willing to take? How long will you keep the money invested? If your investments were to fall by 10 or 20 or 30 percent, what would you do? These are critical questions that you need to ask yourself to guide what investing strategy you should follow.
If your goal is to build long term wealth through your investments, I’d posit that taking a bet on a company like Snapchat might not be the best idea. Even if it does happen to double or triple in value in the next ten years, the risk associated with an IPO like this might not make it a good choice for your long-term strategy.
Instead, I like to focus on stocks that a) have good, long track records, b) pay a steady, reliable income, c) have a history of growing this income every year, and d) appear to be well positioned for the future. Investing in companies like this, done correctly and monitoring and adjusting your portfolio as market situations change, will position you well for long term success.
And, of course, don’t forget the need to diversify. No matter how good a particular stock looks, you should never have more than 5% of your total investments be in any particular company.
And in the meantime, think long and hard before investing in a new stock like Snapchat. Don’t gamble in the stock market- develop your investing framework, and stick to it!