2021 is going to be an exciting year in the stock market and especially in the IPO portion.
The initial public offering (IPO) market has heated up over the past few months. Several high-profile companies have gone public in 2020, including Snowflake, Airbnb, DoorDash, Palantir, and C3.ai. The IPO market is red hot.
The IPO pipeline creates a lot of money for the different participants. For founders and early employees with stock and options, this is the big reward. For the Angel Investors and Venture Capitalists that initially fund the company, the IPO is their exit and payday.
The investment bankers that manage the IPO pricing and process collect massive fees for bringing a company public.
And for investors like you and me who get a shot at owning a piece of the pie, the IPO can be the beginning of a long and fruitful relationship.
We can become owners and ride the unicorn.
A lot said of how the pricing of IPOs is broken, and the tremendous price rise in the initial trading sessions illustrates that companies are leaving a lot of value on the table.
That surplus value is what we, as investors, can participate in reaping.
Once upon a time, like before thirty years ago, the public stock market was the only way to raise the kind of money necessary to build an industrial-scale enterprise. The stock market represented the only vehicle to crowdsource big bucks.
Then, as Silicon Valley and startup culture developed, VCs were able to fund companies. Companies also no longer required massive amounts of money to fund infrastructure. A company could develop in a garage and scale up with a handful of employees and a rack of servers.
Now, with elastic cloud computing, a company can be developed and scaled on a laptop.
This evolution led to companies no longer having to rely on the stock market to grow and scale. Companies that attained a billion-dollar valuation and private became commonplace. They are called unicorns.
The process of funding and developing startups has become more widespread. The cost of getting a product to market has dropped precipitously. In the past couple of decades, it has dropped from millions of dollars to typically between $20,000 to $500,000.
The funding levels are relatively manageable by investors, and the potential returns are enormous. Potential. The risks at this stage are very high of any return.
But the few startups that break out create legendary fortunes. That is why there are startup founders and startup investors.
The exit is the event that represents the big payday for early investors and founders. An investment exit is either an acquisition or an IPO.
An IPO is where a company gets listed and traded on a stock exchange and sells shares to the general public. Until recently, IPOs were relatively rare.
The more usual exit was an acquisition where an established company buys the startup to add to its portfolio of offerings or other strategic reasons.
The company's purchase price is split among the various shareholders, and the value of their pro-rata portion determines their return on their original investment. The exit is the end game goal of venture-backed startups.
But now IPOs are back in vogue, and I'm excited by the opportunities to check them out.
Staying private, or being acquired, boxed out individual investors like you and me from participating in exciting companies and opportunities.
Now many of them are coming to market, and the opportunities to invest are exploding.
We can all get a seat at the table, and this is a time of fantastic possibility and opportunity. We are at the beginning of a digital transformation of every industry and sector. This transformation is driven by elastic cloud computing, big data, artificial intelligence (AI), and the internet of things (IoT).
No company can ignore these convergent waves of innovation. This tech disruption represents an existential threat for every company and great opportunities for those companies that get it right. Every company must adapt or face extinction.
The enterprises that are enabling this transformation are going to be in demand over the next decade. This scenario means significant gains and long-term promise for investors who understand these future trends.
Snowflake is a company that went public in the fall and has seen its stock skyrocket. There is now an investor sentiment about fear of missing out on the next big winner, and the term "Snowflaked" means missing out on an IPO that delivers monster returns.
Nobody wants to get snowflaked, so everyone keeps their eyes peeled for the next round of unicorn IPOs
, and their trigger finger on the buy button.
Around 500 unicorns are queuing up in the IPO pipeline. That means it will be a good number of years for investment banks like Goldman Sachs, JP Morgan, and Morgan Stanley.
Volatility and Options
These newly minted public companies experience high volatility in their price as the initial price discovery period occurs.
The stock market is an auction where buyers and sellers exchange opinions on what they think the company's price is. They are guessing and estimating the present value of the company's potential future cash flows. The aggregate average of all their guesses ends up being the quoted share price. The market capitalization is that price times the number of shares outstanding.
The wide-ranging up and down in the stock price can be disorienting. It can also be very profitable if you invest in writing options. Selling call and put options on a company experiencing large price swings can be a way to make additional income from investing in these unicorns. It's a hedge fund strategy: go long stocks and short options.
2021 is going to be an exciting year in the stock market and especially in the IPO portion. Investing has never been so democratized as now. Online brokerage accounts with zero commissions on stock trades and fractional share investing make it easy to enter the market.
Easy but not simple.
Caveat emptor, buyer beware. You must do your homework and understand the companies and the market before committing your hard-earned money. This opportunity isn't about gambling and speculation; it's investing.
Warren Buffett famously reads 500 pages per day of company and investment information. That is the level of commitment we all need to make to thrive and be less stupid. Read up on science, technology, future trends, and investing. Time to do our homework!