Stephen’s note: I’ve got something special for you today. Instead of my regular weekly note, I’m sharing a conversation I recently had with RiskHedge Senior Editor Justin Spittler. Justin specializes in a speculative stock sector that routinely produces big, quick profits. Read on to discover more about this unique but misunderstood corner of the markets...
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Stephen: Justin, nice call on the Match Group (MTCH) a few weeks back. Some happy readers wrote in asking to hear more from you after it jumped 24%.
You’ve worked mostly behind the scenes at RiskHedge for a while. Tell readers what you do... and tell them why our publisher Dan calls you the “unicorn hunter.”
Justin: Well, a “unicorn” is a young, private company worth $1 billion or more that does not yet trade on the stock market. They’re called unicorns because they used to be rare.
These days they’re more common. So far, 48 unicorns have gone public, or “IPO’d,” this year. Another 400 are still in the “pipeline,” according to CB Insights. Many of these companies will go public over the next year or two, meaning huge profits are up for grabs for investors who know how to play IPOs.
It’s an exciting time. There’s never, ever been an IPO pipeline like this.
Stephen: For readers who don’t know, can you explain exactly what an IPO is?
Justin: An IPO is when a stock starts trading on the market for the first time. It’s the first opportunity most investors have to buy into a company. Before a company goes public it’s in the hands of private investors, like venture capitalists. The IPO opens the floodgates for 99% of investors to get their hands on the stock.
Stephen: Why specialize in IPOs?
Justin: It’s one of a few areas where individual investors can make a lot of money, often very quickly. Get into the right IPO at the right time, and a doubling, tripling, or quadrupling of your money is a real possibility. I’ll give you some recent examples: Guardant Health (GH), which specializes in cancer diagnostics, soared 490% in just eight months after its IPO. Software company MongoDB (MDB) spiked 470% in under two years. Cybersecurity company Zscaler (ZS) gained 460% in 16 months. And ShockWave Medical (SWAV) returned 300% in three months.
Then, there’s Roku (ROKU) and Beyond Meat (BYND), two better known companies. Roku, a company cashing in on the “cable-cutting” craze, soared 915% in under two years. Beyond Meat, a company that makes plant-based “meat,” leapt 859% in less than three months!
Readers should know these examples aren’t rare, nor are they “cherry picked”. By my numbers, 41 IPOs have returned at least 100% in the last two years alone.
Stephen: You mentioned it’s possible to make a lot of money from “the right IPOs.” Tell me what they look like.
Justin: Sure. First off, it’s important to know there are plenty of dud IPOs. I want to be clear that the IPO market is no place for amateurs or part-time investors. Investors who blindly buy a “hot” IPO risk getting their pockets vacuumed out.
I say that because the biggest, loudest, most hyped-up IPOs—the ones everyone knows about—tend to be suckers’ bets. If your barber or your cab driver bring up an IPO in casual conversation, odds are it’s going to be a flop.
Stephen: Uber comes to mind...
Justin: Exactly. Uber (UBER) was a household name and a massive company when it went public in May. Long before its IPO, it had already raised more than $24 billion in seven funding rounds. By the time it went public, early investors in the company had already made a killing. Cyclist Lance Armstrong netted about $20 million off a $100,000 private investment in Uber.
By the time Uber IPO’d it was worth $82 billion! That’s far, far bigger than traditional car companies like Ford, General Motors, and Tesla. Naturally, there was a ton of excitement around Uber’s IPO. But it didn’t live up to the hype. Uber shares plunged 7% on their first day of trading, and they’ve yet to find solid ground. Uber is down 26% since its IPO.
Lyft (LYFT), Uber’s biggest rival, suffered a disappointing IPO, too. Lyft went public in March at a valuation of $24 billion. It was one of the most anticipated IPOs ever.
But, like Uber, it failed to deliver. Lyft’s stock has plummeted 34%.
Stephen: How about WeWork?
Justin: Everyone’s talking about the We Company (the parent company of WeWork), which is set to go public this month.
To say I have low expectations is putting it mildly. The We Company is one of the worst IPOs I’ve ever seen. And I’ve analyzed the returns of more than 8,000 IPOs, so that’s saying something.
For readers who don’t know, WeWork’s main business model is to lease out office buildings, then re-lease the individual offices to freelancers or other folks who need a place to work.
I spent a week at the WeWork office in Mexico City. It was nice... free coffee in the morning, free beer on tap in the afternoons. People bring their dogs to work.
But as a business, it’s a dumpster fire. Strip away the novelty and it’s just a cash-incinerating real estate company masquerading as an innovative tech company. And yet, the We Company was most recently valued at $47 billion. My research suggests it’s fair value is $10 billion, max.
Plus, WeWork is probably the most talked- and written-about IPO since Facebook’s 2012 blockbuster. It is pretty much the exact opposite of what you want to see in a lucrative IPO.
Stephen: Elaborate on that.
Justin: Think back to the wildly successful IPOs I mentioned earlier—Guardant Health, MongoDB, Zscaler, ShockWave Medical. Notice they are not household names. I doubt even 0.1% of the people reading this have even heard of these stocks, even though all four have soared 400%+ since going public.
Even Beyond Meat was virtually unknown before its IPO. Today, most investors know the company’s story. Achieving 859% gains in two months will put you on the map.
Generally, you want to seek out IPOs that aren’t well known, whose products and services aren’t famous yet. Often, the truly lucrative IPOs are virtually anonymous when they go public. They achieve fame later as investors who bought near the IPO get rich and the story starts to get out.
Stephen: You also study who is invested in a private company before it IPOs.
Justin: Yes, this is absolutely crucial. Remember, an IPO isn’t the first time anyone is allowed to invest in a company. It’s just the first time you, as a public investor, are allowed to invest in the company. Founders, venture capitalists, and others have likely been invested in the company for some time.
The right IPO strategy lets you invest alongside the venture capitalists. Venture capital is probably the single most lucrative investing strategy there is. Venture capitalists often achieve returns of 10,000 to 1 or even 100,000 to 1. Investing in IPOs the right way lets you piggyback on some of those crazy returns.
Stephen: So who you’re investing alongside is as important as what you’re investing in.
Justin: Yes... without naming names, there are venture capitalists you want to invest alongside, and others you want to avoid.
I should add there’s one telling datapoint I’ll look at before almost anything else. I look at how much money a company has raised prior to IPO’ing. Companies that have raised billions of dollars rarely deliver monster gains in the months following their IPOs. You might say they’ve already been “milked dry” by private investors.
See, the right private companies have a tremendous amount of “potential energy” pent up. When a company is private, hardly anyone can buy it, so there’s nowhere for this energy to go.
It’s like a pressure cooker. The day its stock goes public is like a pressure release, and its stock can shoot off like a geyser. It’s why the best IPOs can often rocket 50% or more in a week... and 2X, 3X, or 4X in a matter of months.
Raising a ton of money before an IPO pokes holes in this “pressure cooker.” Remember I said Uber raised $24 billion ahead of going public? Roku raised just $209 million, less than 1/100th of that. Beyond Meat raised only $122 million.
Again, their stocks have leapt 915% and 859% since they IPO’d, both in under two years.
Stephen: Is hunting for IPOs a “bull market only” strategy? Does it work when markets are struggling?
Justin: A lot of people think that. I understand why it’s the conventional wisdom. But it’s wrong.
A unique thing about IPOs is they have a “mind of their own.” As readers probably know, most stocks tend to go with the trend. It’s hard to find rising stocks in a falling market.
IPOs often buck the trend.
Visa (V), for example, went public in March 2008. At the time, it was the largest US IPO ever.
The timing couldn’t have been worse. Just five days earlier, JPMorgan (JPM) offered to buy the troubled investment bank Bear Stearns for $2 per share.
They were the darkest days of the financial crisis, and the markets were in a full-blown meltdown. The S&P 500 had fallen 17% in five months leading up to Visa’s IPO. It went on to plunge another 48% over the next 12 months.
And yet, Visa jumped 28% on its first day of trading. Less than two months later, its share price had doubled. Stephen, this was during the worst financial crisis since the Great Depression!
Today, Visa trades at $178. That’s good for a 16-bagger.
More recently, several IPOs have performed great despite choppy markets. Tilray (TLRY), a cannabis company, returned 1,665% between July and September 2018. Zscaler, which I mentioned earlier, surged 193% in five months. Keep in mind, the S&P 500 ended last year down 4%.
Stephen: So, you aren’t just “flipping” IPOs. You hunt for long-term winners.
Justin: Yes, you’re not going to make 5,000% or 10,000% gains within a few months, though. It usually takes years for an IPO to achieve those life-changing returns.
But as I’ve emphasized, IPOs are a speculative area of the markets. It’s like the roped-off, high-stakes poker table in the back of the casino. Only pros should sit down. 19 out of 20 investors have no business speculating in IPOs.
Stephen: Anything else readers should know?
Justin: My job is to take the risk in IPOs, understand it, control it, and reduce it. If you can do that, you eliminate most of the downside and you’re left with a huge upside.
For example, say I buy an IPO and it doubles in four months—which isn’t all that rare. I’ll often sell half my position to recoup my whole initial investment. Then, I let the other half “ride.”
By taking a “free ride,” you pocket a quick double and remove all your risk. Then, if the stock goes on to achieve a 10X profit like Google (GOOG) did after its IPO, or a 20X profit in four years like Shopify (SHOP) did, you stand to collect very large profits with zero risk.
Stephen: Where can readers hear more from you?
Justin: I’ll be writing the new Tuesday edition of the RiskHedge Report. Readers can expect it to land in their inbox around 5 pm EST every Tuesday.
I’ll analyze companies that have IPO’d recently. I’ll take readers “in the room” and tell them about hot upcoming IPOs. And of course, I’ll tell readers which big, hot IPOs to avoid, like WeWork.
Stephen: And your weekly letter is free, right?
Justin: Yes. In short, it will be similar to your Thursday edition of the RiskHedge Report, but better.
Stephen: [Laughs]. We’ll see about that. Look forward to reading it.
Stephen’s Note: Have you ever invested in an IPO? If so, tell me about it at firstname.lastname@example.org.
Editor, Disruption Investor