Tech stock IPOs pose an incredible challenge to investors. After all, traditional stocks are meant to be held long-term, and tech companies have a tendency to come and go. There have been numerous IPOs in the last decade that were complete failures, even though the market showed great confidence.
So what are the hallmarks of a bad tech IPO? Truthfully, it’s a lot easier than you might think.
When Good Companies Produce Bad Stock
Even in the informational age we live in, there’s a lot of confusion when it comes to what makes a tech company good. If a retail store has thousands upon thousands of customers, it’s a good thing. But that isn’t necessarily a good thing when it comes to a tech company.
Tech companies have entirely different metrics that they need to follow — most specifically, their path to monetization.
When it comes to companies such as Facebook and Twitter, they have a tremendous amount of reach, influence, and power. But they don’t necessarily have a very clear path to monetization — they don’t always have a plan for how they are going to make money from their users. There are many tech companies that are actually operating in the red, and continue to operate even more in the red the larger they grow.
Interestingly, Facebook’s IPO was actually a failure largely due to unwarranted optimism. Many investors didn’t understand what made the social media giant company a good company, ultimately leading to a runaway valuation that the fundamentals simply could not support.
This can also happen with particularly noteworthy tech IPOs, as casual investors may be introduced and may have this type of confounding impact on the market.
Interestingly, this also caused some confusion when it came to early Amazon stock. Amazon is notorious for losing money, and their stock was long considered nothing more than a joke. As Amazon has developed additional monetization paths — most notably, their AWS services — they have been able to increase revenue and their stock has risen substantially.
Top Red Flags for a Bad Tech IPO
• What about their fundamentals? Tech companies are too commonly sold based on their popularity and their reputation. As with any other company, the fundamentals are more important: management, cash flow, income statements, and other financial documents.
Tech companies are also notorious for poor management styles, or simply rocky management styles, which can destabilize the entirety of the company. These are things that need to be investigated before an investment is made. Luckily, the information is usually fairly public.
• What about their monetization? How is the tech company making money now… and how are they going to make money in the future? Twitter is popular enough that many investors have wanted to jump in, especially as it has been able to increase its user base.
But Twitter actually doesn’t have any clear paths to monetization, apart from promoted posts and other peripheral services.
Tech companies have historically struggled with monetization; though they can build popularity and user bases, they may not be able to turn that user base into functioning revenue. Furthermore, attempts to monetize after an IPO may cause a backlash, as they may alienate the existing user base.
• What about their investors? Finally, one of the largest reasons that a tech company may enter into the IPO market is because private investors have run dry. This could be because the market is over-saturated, but it could also mean that there’s something wrong with the company itself. It may have already absorbed too many debts or it may simply be growing too aggressively.
Regardless, the reason for the IPO is very important. The best tech IPOs often enter into an IPO for reasons of liquidity or because primary investors are cashing out. They don’t enter into an IPO because there’s no other path.
So when should you invest in a tech IPO? When the fundamentals are good, when the path to monetization is set, and when the company has a reason for opening up. The Tesla IPO was an excellent example of a tech stock that hit all of these major points; Facebook was not.
Tech IPOs always have some inherent level of risk, but when they perform well, they become the Googles of the stock exchange.
Regards,
Ethan Warrick
Editor
Wealth Authority
