Initial Public Offerings (IPO’s) have been hot the past few weeks which is making a lot of people wonder if the stock market as a whole is overheating. I’m not necessarily concerned with the amount of new IPO’s so far this year but I think the stock market is still pretty stretched after last year’s big run and momentum has been weak, leading me to believe we’re in for some further choppiness.
As for IPO’s, it’s extremely difficult to get an allocation of shares in an IPO these days leaving us to decide whether or not to buy after it begins trading. Generally speaking, I’m not a big fan of buying new IPO’s because a large majority are worked to make the debut look great by creating a huge pop. The other (and main) reason has to do with the “lock-up” period. Every new IPO has a lock-up period where company executives and early investors like private equity companies are restricted from selling their shares, typically for 6 months. If they weren’t, they could game the IPO to jump really high on the first day by issuing a very small amount of shares (smaller than the demand from investors) and then dump their shares after the stock is up 50% or 100%.
Most insiders don’t care where the stock is trading once the lock-up period ends – they want to sell some of their shares to cash-in and most likely diversify their personal holdings. Being aware that a large volume of shares are going to be sold by insiders right after the lock-up period, many hedge funds will sell (sell short) the stock down for the entire 6 months from the first day of trading to the end of the lock-up period, knowing that there will be plenty of selling volume from the insiders for them to buy to cover their shorts.
I see this same pattern time and time again with IPO’s: poor performance during the first 6 months and then it magically reverses course and starts rising. This is exactly what has been happening with Potbelly Corp (Potbelly sandwiches) which went public at the beginning of October. Their lock-up period is set to end next week so I started buying some of the stock yesterday. Now, I wouldn’t just do this because a lock-up period is ending; the fundamentals have to be right too, and I think they are at this price.
After they went public, I initially had my eye on $21 as a target price I was willing to pay so I had no problem stepping in yesterday when it was trading down 4.5% and under $18. I’m starting small though because the insiders own a somewhat large portion of the outstanding shares (73.8%) and if they want to sell a lot of those shares, PBPB could press even lower.
Potbelly (PBPB) – 6 months (since IPO)
Stay tuned – next week I’ll be announcing details on a webinar I’ll be hosting in April. Thanks for following and have a great weekend!
-Nick
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