How to Identify, Trade and Handle Recent IPOs
I’m always watching the IPO market because so many IPOs morph into new leaders. That’s especially true when many later-stage leading stocks (those that have had huge, huge runs during the past year or two) are beginning to look tired. Once this market correction ends, chances are some of these recent IPOs will help lead the next upturn.
What’s interesting is that, even as the overall stock market has floundered and sentiment has worsened, we’re seeing a solid stream of new issues hit the market. For instance, there was $30 billion, $18.8 billion and $35.5 billion raised by new issues during 2015, 2016, and 2017 (respectively), but through April of this year, there has already been nearly $26 billion raised.
Even more important from my point of view is that we’re seeing some real growth-oriented companies go public. For many years after the financial crisis, IPOs tended to be yield-oriented issues (REITs, pipelines, etc.). There are still a good number of those, but now there are a bunch of software, internet and even retail issues that have hit the market during the past year or two.
Thus, I see great potential for some of these stocks. That said, before getting to some names, it’s important to note that handling new issues is far trickier than handling normal stocks, and it’s not hard to understand why. With little institutional support, IPOs are usually thinly traded and can flop all over the place based on the market, industry moves and the like.
Thus, if you’re interested in playing these young stocks, there are three simple guidelines to follow.
- Keep positions small and stops loose to compensate for the added volatility.
- Buy only after the IPO has traded for a few weeks and shown some constructive signs. What kind of signs? Usually a tight consolidation, though that can occasionally happen after a big drop or wild trading range.
- Buy only if the stock starts to show strength. That’s hard for most investors, but it’s usually necessary for IPOs because so many of them crash and burn for months after coming public. If you wait for some strength, you’ll be able to avoid most of the duds.
With that in mind, here are two recent IPOs to watch.
Recent IPOs to Watch
The first recent IPO to watch is Spotify (SPOT), which is the largest global music streaming company (more than 35 million tracks!). The stock is high-priced and already very liquid (it’s traded at least a million shares every day since its IPO), a sign that big investors are active. And the potential here is huge: Spotify could be the next big internet success story, with its music streaming service used by around 157 million people near year-end and still growing rapidly.
About 86 million of those users have signed up for the company’s free streaming service, which allows shuffle play but has limited skipping ability and includes advertisements (sort of similar to Pandora). In itself, this is a solid business, with revenues up 51% and 41% (thanks to ads) during the past two years.
Even so, it’s the company’s Premium offering that is driving growth and accounted for 90% of total revenue each of the past couple of years. Paying subscribers ($10 per month) get not just access to the company’s entire music library, but see no ads, can skip around, build their own playlists and even download songs for offline listening. At year-end, Spotify had a huge 71 million paying subscribers, and revenue from this premium segment lifted 38% last year.
There’s competition, of course, with Apple Music being the most direct threat, but Spotify has nearly twice as many paying subscribers as Apple (AAPL) and, in my view, there’s room for two or three big boys in a mass market of this size. I think Spotify has years of great growth ahead of it.
As for the stock, SPOT has handled itself well since coming public on April 3, mostly hovering between 140 and 160 despite the weak overall market. And in recent days, shares have actually perked up to new closing highs. I’d like to see another couple of weeks of consolidation (and a healthier market) before buying, but the action is very encouraging.
The other recent IPO to watch is Dropbox (DBX), which is a leading cloud collaboration platform for businesses, with more than 500 million registered users (and 11 million paying users) and north of $1 billion of revenue last year. The company’s offerings solve a simple but widespread need—allowing workers to access whatever they need at any time from any device, and (more importantly) cutting down on wasted activity like searching for content, switching between applications and managing workflows.
Basically, as the workforce becomes more global and mobile, and as content continues to be created in various different apps, demand for Dropbox’s centralized offerings (a unified home for all key content, in essence) will continue to grow.
Revenues have grown 40% and 31% during the past two years, and while earnings remain in the red, analysts see that changing this year (a small profit of 20 cents per share is anticipated) and free cash flow is already surging, totaling nearly $300 million in 2017 (about 90 cents per share).
DBX came public on March 23 and has since done almost nothing, mostly hovering between 28 and 33. But that’s OK with me. Many times IPO winners form reasonably tight ranges for a couple of months after going public before taking off. That’s what I’ll be watching for with DBX—another week or two of calm action and an eventual liftoff above 33. It’s possible that earnings, which are due out May 10, could provide a catalyst one way or the other.
There are sure to be more vibrant IPOs to watch in the months ahead. The best of them will show up in Cabot Top Ten Trader, which is the #1 source of new, buyable stock ideas for individuals and professionals alike. (Among all of Cabot’s advisories, Top Ten has by far the highest proportion of professionals and money managers as subscribers.)
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