Trading in Newly Public Companies
The dot com bubble is one of the most important periods in financial history. During this time, newly-formed countries debuted to the public market. Many investors – who included many day traders – ventured in the business of buying stocks of new dot com companies.
The craze was started with the debut of NetScape, a popular web browser that went public and became a multibillion dollar enterprise. Soon after, dot com companies started becoming public with ease. Even companies that were in business for decades, changed their names by adding dot com in the suffix. Their valuations went over the roof.
Most of these companies had huge debts, had no cash flow, and were burning cash fast. A few months later, most of these companies went burst and became bankrupt.
To some extent, We feel as if we are in the same situation. Instead of the dot com bubble, We feel as if we are now using terms like Artificial Intelligence, Machine Learning, Augmented Reality, and social among others.
A Technology Bubble in the Making
Companies that have simple products to understand have incorporated these terms in their strategies to attract investors.
A few months ago, a company called Grammarly that offers grammar check solutions raised more than $100 million. Its claim to fame was that it used machine learning and artificial intelligence to help people write better. However, when you look at the company, it is clear that AI and ML are not involved in how it does business.
A few months ago, several tech companies went public. Companies like Snapchat, Blue Apron, Redfin and Carvana went public attracting multibillion dollar valuations. Snapchat offers an app where people can share disappearing messages. Blue Apron on the other hand ships ingredients to customers who subscribe to their services.
Redfin offers an app and website that helps people search for houses to rent. Carvana offers a website to help people buy cars. They have expensive giant car vending machines where people can retrieve their cars.
Before their IPO, these companies were hot startups classified as unicorns.
Many investors are attracted to such companies, because they believe that these companies will become the next multibillion dollar companies like Facebook and Google. They believe Snapchat will become bigger like Facebook and Google, or that Blue Apron will disrupt the huge groceries market. They believe Carvana will replace Autonation and other car dealers while Redfin will replace housing agents.
However, most investors who rushed to buy these companies have been disappointed. Their share price has declined significantly and investors have lost a lot of money. Yet, this could be avoided if the investors took time to review the companies.
Several questions you should ask yourself
Does the company make money?
If you want to go long such companies, you need to ask yourself this question. This is because if the company will realize its growth, it needs to be making money. If the company is not making money, then you should look at the user growth. Investors love unprofitable startups that are adding their number of users. However, they love such companies if their customer acquisition costs are not high.
What is the economics of the business?
Ask yourself whether there is any signs of growth in the company and whether the company is paying a lot of money to acquire customers.
The company has any competitive advantage over its competitors?
When Snapchat came to the market, they did not anticipate what Facebook did. Since their product was not patented, Facebook incorporated its product into their products such as Whatsapp and Instagram. Today, Instagram stories is more popular than Snap. Before Blue Apron became public, Amazon acquired Whole Foods in a bid to disrupt the groceries market.
What is its strategy to make money?
You should take time to read the S1 document all companies are required to file before becoming public. The S1 document will show you how the company makes money and its strategy going forward.
By carefully studying the document, and criticisms from critics, you will know whether to buy tor short a company after IPO.
Useful external resources for Trading in Newly Public Companies
- To discover more, please go to Investopedia;
- Another interesting reading on Mlcollins;
- To find further information, please visit Nasdaq.