How to Profit Big From IPOs—and Avoid the Risk

Strong IPOs vs. Weak IPOs

There are few better ways to make strong gains in a short period than through an initial public offering (IPO). IPOs are a fantastic entry point for investors, as they represent the first opportunity for investors to get in on what may be a revolutionary, exciting, or otherwise solid company.

Before its IPO, a company exists in the realm of private finance (where most people simply don’t have the funds to participate), but post-IPO, it’s fair game.

But IPOs can also be dangerous—as we’ve seen in the recent past—because, once companies hit the public markets, they’re not just selling dreams, they have to begin to make a coherent pitch to investors of all stripes.

So how do investors tell the difference between a strong IPO and a weak one?

Let’s take a look at several recent initial public offerings, dissecting what made each one successful (or not), and what lessons you can use to profit from future IPOs.

Beyond Meat IPO

We couldn’t rightly publish this article without examining the 2019 IPO that everyone has been talking about: Beyond Meat Inc (NASDAQ:BYND).

Beyond Meat stock has surged by as much as 300% since its IPO, representing one of the strongest returns we’ve seen from a major new stock in years.

So what made BYND stock so appealing to investors when it hit the market? It’s a simple yet potent combination: innovation mixed with solid foundations.

The innovation part comes by way of the company being the first meat-alternative stock to hit the open market. That means the company is giving investors a chance to gain exposure to a fast-growing new market.

Innovation and novelty, as we’ve seen countless times before on the stock market, often wins out.

Now, innovation and novelty on their own are one thing, but you can’t depend on “potential” forever (as some weak IPOs have). Once public, companies have to start showing results.

And Beyond Meat has done just that.

Net revenues were $92.0 million, up 250% from the previous year. Gross profit was $32.8 million (35.6% of net revenues), compared to $5.0 million (19.2% of net revenues) the same time a year prior. (Source: “Beyond Meat Reports Third Quarter 2019 Financial Results,” Beyond Meat Inc, October 28, 2019.)

Net income was $4.1 million ($0.06 per diluted common share), compared to a net loss of $9.3 million ($1.45 per common share) in the previous year. Adjusted EBITDA was $11.0 million, compared to an adjusted EBITDA loss of $5.7 million in the 2018 third quarter.

Marijuana stock IPOs in the past have similarly benefited from this potent combination, being among the first available stocks in this sector while also having a solid foundation, with potentially hundreds of billions of dollars in sales.

Not to mention that marijuana companies and Beyond Meat will both see recurring revenue for years to come as they’re selling consumables rather than, say, tech products, which many people will only buy every few years, if that.

Now, there is a problem with explosive IPOs like the one that Beyond Meat stock experienced. Climbing that high that fast causes investors to panic and inevitably creates a backlash.

BYND stock soared with gains as high as 1,000% before falling precipitously in recent weeks. Still, any investor who got in on the IPO is smiling all the way to the bank.

UBER Stock IPO and LYFT Stock IPO

Two other notable companies that went public in 2019 were not nearly as successful as Beyond Meat: Uber Technologies Inc (NYSE:UBER) and Lyft Inc (NASDAQ:LYFT).

Both ride-sharing apps came in hot and heavy with big valuations and millions of dollars in revenue on their financial statements.

The problem with both UBER stock and LYFT stock, however, was that the companies were overvalued. These bloated stocks hit the markets and, despite having the potential to make billions of dollars in profits in years to come, they had simply waited too long to hold their IPOs.

Investors were no longer excited about these companies, and both Uber and Lyft suffer from spending an outrageous amount of money while having little chance for profit in the near future.

While the chance for billions of dollars in the future is possible, the reality is that Uber and Lyft are losing billions right now, and that scares investors.

Now, both of these companies are still solid stocks that could pay off in the future, but their IPOs were nothing short of disappointments.

The lesson here for investors is that, if a company spends a long time in the public eye but doesn’t file for an IPO, that can create boredom among investors.

Stagnating as a private company for too long means the IPO will be that much harder to pull off, as the most successful IPOs are typically a function of novelty and excitement.

Nobody was excited for these massive—some would say bloated—companies, and that has showed in the weak performances for both UBER stock and LYFT stock.

Chart courtesy of StockCharts.com

TLRY Stock IPO & Other Marijuana Stock IPOs

While this piece is mainly concerned with 2019 IPOs, it’s worth looking at Tilray Inc (NASDAQ:TLRY), if only because I believe there will be a second rush of marijuana IPOs that investors can earn huge profits from if played right.

TLRY stock, you may remember, went public in 2018 as the first marijuana stock to list on the Nasdaq. There was a fervor surrounding the company, with investors flocking to the first marijuana stock to hold an IPO on a major U.S. stock exchange.

Tilray stock, much like Beyond Meat stock, surged in the initial weeks that followed its IPO, creating massive profits for early investors. But I wasn’t convinced.

There was nothing particularly special about Tilray, other than it being the first pot stock to list on the Nasdaq. It had novelty, but no fundamentals to back it up.

I was bearish on TLRY stock in the weeks that followed its IPO, and I was proven correct. After that initial spike, Tilray stock plummeted for months until it hit its current trading price.

While the company has still netted day-one investors 35% returns, that’s a huge collapse compared to its over-1,100% gains in the months directly following its IPO.

Chart courtesy of StockCharts.com

And that brings us to the topic of future marijuana-stock IPOs, which could be the best way to score big gains in 2020 and beyond.

You see, the U.S. is closer than ever to legalizing marijuana at the federal level.

Presidential contender Bernie Sanders recently shared a post over social media claiming that pot must be legalized in the United States. Many of the Democratic Party’s other presidential hopefuls are of a similar mind.

If any of those candidates win the presidency, there’s a good chance we could see federal U.S. marijuana legalization begin in earnest in 2020.

While any marijuana reform would have to pass through Congress, a supermajority of Americans support pot reform, making it an easy sell for politicians.

Marijuana IPOs were hugely successful for investors who were able to get in on the ground floor, seeing gains of 500%-plus over the past few years. The next crop of U.S. marijuana IPOs could eke out similar gains in the coming years.

Analyst Take

When it comes to buying low and selling high, IPOs are among the best ways to fulfill that old adage.

Some stocks are never as cheap as their IPO price, some start strong but flare out, others are flat right out the gate, and some start slow but see a stronger trajectory over time.

Being able to effectively judge and anticipate a very strong IPO is how many investors are able to earn vast sums of money in short periods (just ask anyone who bought Beyond Meat stock early).

Even stocks that show weakness over time can be profitable for investors who buy at the beginning if they are able to sell at the right time (as many Tilray investors can attest).

The long and short of it is that IPOs are among the best ways to make a lot of money fast in the stock market. Investors who are able to play the market well could see their portfolios swell.

Playing it well is more complicated than it sounds, and involves following companies closely and judging winners from pretenders, but a good rule of thumb is the one I have outlined here: look for novelty/innovation and solid fundamentals heading into an IPO.

Those two factors combined are often the best way to predict that a massive IPO surge is coming.

With so many industries in their nascent stages, IPOs offer a fantastic way for investors to potentially see massive gains.