Everyone always loves a new and exciting company that is initially launching their stock on the market for the first time. Whether it's Snapchat, GoPro, or any other company, there seems to always be a hype around being the first buyer into a new company being listed on the stock market. However, as a responsible investor, you should always be aware of the many risks associated with buying an IPO stock.
An "initial public offering" (or IPO) is the introduction of a stock on a publicly traded market at a specified price. This specified price is usually determined based on the company fundamentals, market cap, goodwill, and other financial metrics that are more known to investment bankers and other financial institutions who have insight into this private company's fundamentals (this information is relatively unknown to the general public).
The IPO price is offered to accredited investors (such as large investment firms) and other financial institutions and solicit bids. These "high quality names" will express interest in demand of a certain number of shares, but might actually only get a partial fill on their order due to such high demand of shares and other competitive bids from other prospective buyers. For example, if an institutional investor expresses interest in buying one million shares, they might only get 10% or 100,000 shares "filled". Some institutional and other accredited investors will receive a better fill on their orders because of the institution's reasoning behind why they're buying of shares (i.e. company valuations), in which they would give a better analyst "rating" or "score" for this stock. Also keep in mind that financial institutions (banks) will give priority fill to institutional clients (investment or asset management firms) that support them. It's pretty much a "I scratch your back and you scratch mine" kind of deal, in reality. It is possible that due to such high demand that some institutional investors may not get a fill on their buy order at all. In the end it's a crap-shoot and the majority of financial institutions or other accredited investment firms only generally get 20-30 percent of the initial buy order for any IPO. The remaining IPO "paper" or shares up for grabs will trickle down to high profile retail brokers who will by shares for their best clients.
When an IPO stock opens on the market for the first time, what will typically happen is that the stock will open much higher than the listed "IPO price" due to all the buying volume that has already happened between institutional investors, banks, and other brokers. Any high profile IPO is almost impossible for an average investor to get shares at the specified IPO pricing.
Once a stock has made it's IPO debut, these institutional buyers and accredited investors must hold the stock for a minimum of 6 months after the IPO purchase before selling. Therefore, there is typically a giant sell off at the 6 month point followed by a short term downtrend in the stock as these accredited investors try to lock in profits. The figure below shows trends of various stocks over the course of its first year of being on the market. Notice how at the 6 month mark, there is a general sell off, resulting in a dip of the stock price. Of course this isn't true for all stocks (Sleep Country ZZZ and Spinmaster TOY for example), but as concrete results become available every quarter, stocks trends tend to correct towards "reality":
New IPO stocks are so volatile within the first few months of trading, primarily because trading volume is driven by hype and speculation since there is hardly any publicly shared information about the company concerning its fundamentals, financial statements, valuations, or earnings projections. It isn't until a few quarters of company fundamentals and performance later when a stock typically starts behaving in relation to its earnings and outlook projections.
So if you want to avoid unnecessary stress and uncertainty, don't buy IPO stocks at least until after the 6 month point. It would be more wise to wait for the company to release earnings for a few quarters first to get a sense on its valuations and future performance projections before deciding whether the stock is a worthwhile investment.
Now ask yourself this: Does a company like Snapchat really deserve a $20 per share price given that it generates no net income but negative earnings instead for 2017? I don't usually recommend stocks in these lessons but this will be an "IPO stock" I'll have on my short list.