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What’s the Best Way to Invest in New Companies? SPAC vs. IPO

Having the Fear of Missing Out, or FOMO, is literally one of the worst things that an investor can have, but it’s so easy to do! If you turn on CNBC, you’ll regularly hear about the next company that you can invest in and if you’re like me, you’re going to get super hyped up to get in early, but can you? It’s time to break it down with two great methods – SPAC vs. IPO!

First, let me start with an IPO, or Initial Public Offering. Maybe people have probably heard the term IPO before so they might be more knowledgeable with this sort of method when a private company becomes public.

Essentially what happens is that these private companies will hire investment banks to manage the entire process. They’ll set the best time to go public, gauge the demand of the company’s shares, set the IPO price and even determine the date that they’re going to go public.

In general, it looks something like this chart from the Corporate Finance Institute:

Now, unfortunately, it is extremely hard for us “retail” investors to be able to buy shares of these IPO stocks before they hit the market. That might not seem like a big deal if you’re just starting to learn about this process but trust me, it really is.

IPO’s have been HOT lately and the pricing that people are willing to pay is simply ludicrous. Remember, you haven’t really seen a ton of history with this company but you have seen an S-1, which is an SEC filing required to take a company public that does have some consolidated financial data.

For some reason, people just get infatuated with these IPO’s and want to invest at literally any cost at all. Maybe it’s because it’s something that is new and shiny or maybe there is a completely different motivation behind it. We have seen some just go crazy over the past few years like Uber and Beyond Meat, but the one I want to drive down into is Snowflake (SNOW).

The reason I really want to talk about SNOW is because it’s by far the company that I have loved the most, prior to becoming a public company. I had heard about them from a few different of my favorite podcasts and it made me do some more research and I fell in love with them.

I loved the fact that they were a cloud company in a world where cloud is exploding with insane returns and also that they had some absolutely astounding revenue numbers. I was dead set on investing in this company once they IPO’d and I could get my hands on some shares.

Well, the issue that I didn’t really think about is that you know how I found out about them on a podcast?

Well, so did a ton of other people. And the hype for this company was just stupid. Like really, really stupid.

So stupid in fact that the price of these shares just skyrocketed. Look at the history of pricing:

  • Initial Price Recommendation – $75/share
  • Updated Price Recommendation – $85/share
  • Updated Price Recommendation – $120/share
  • Initial Price for the Common Investor – $245

Yes, I am not lying – the price that you could’ve bought Snowflake for was $245. Just a mere 327% of the initial price recommendation of $75.

Doesn’t that just seem ridiculous? Kinda feels a little bit rigged to me.

Now, investing in companies fresh off their IPO didn’t always used to be like this, but there’s this sense of hysteria around new companies where people can’t get enough of them. They’re so eager to invest in these sorts of companies like Airbnb where the stock just goes absolutely insane that first trading day.

I totally understand going crazy over a stock that you have fallen in love with and dumping a ton of money into them, but all of these new companies just seem to be nothing more than hyped up speculative investments with no profits and small revenues.

Admittedly, I am a sucker for these speculative investments but I keep them to a small percentage of my portfolio because they’re just so dang risky.

“Our profits grew by 400% last year!” – freshly IPO’d company

“From what – $1 to $4?” – Me

Obviously, that’s an insane hyperbole, but you get what I’m saying. You’re not going to see Disney 4x their revenues in a year cause they’re a massive, established company.

But fortunately for us, there are other ways to get in some new companies, and that is with a SPAC, or Special Purpose Acquisition Company.

A SPAC is essentially a shell company that is created and then publicly traded on the market. Their goal then is to find an acquisition target and purchase them, effectively bringing that company public.

The SPAC literally has zero operations, revenues, profits, anything, until they acquire that company – yet you can still buy shares. Sounds like the definition of speculation, right?

SPAC’s have really been a new trend in recent years because of this extreme market volatility that we have been experiencing. SPAC’s are a more sure-fire way to get that company to go public and a lot of times they’re started by gurus like Chamath Palihapitiya.

You might’ve heard of Chamath during the recent trading frenzy with GameStop and the Reddit users, but he really has quite the bio as an early Senior Executive at Facebook, minority owner of the Golden State Warriors, and one that brought other major companies to market via the SPAC route such as Virgin Galactic and Opendoor.

He also is leading some SPAC’s now that are rumored to acquire SoFi, the personal finance and investing platform that you might be familiar with regarding student loan restructuring.

The thing that I like about the SPAC’s is that you have the ability to invest in that specific company as soon as the news on the street is leaked out. For instance, when the rumors started to fly about SoFi being an acquisition target, you could go buy that shell company with the hopes and anticipations that they actually do acquire them.

Now, again – this is purely speculation. Everything could end up being just about nothing and for whatever reason the deal falls through. Or, maybe they never were planning to acquire SoFi in the first place.

In general, the SPAC timeline is shown below from an awesome article from PWC talking about the ins and outs of how SPACs work:

Now, onto the fun part – can you actually partake in this IPO and SPAC investing?

Well, I have good news and bad news…

You certainly can, but likely not in the matter that you want to…

Let me explain first with talking about IPO’s.

It’s basically impossible for the common retail investor to get into these companies prior to them hitting the open market. Now, I was hopefully optimistic that if I bought into an ETF, then maybe that ETF would have the buying power to get into these companies prior to them hitting the market…wrong.

So, you basically have two options, and they’re the same two options with investing in any stock:

1 – Buy the stock on its own after it’s on the market

2 – Buy an ETF that also owns that stock

Womp womp. I told you it likely wasn’t what you wanted to hear.

There are some ETFs out there that track IPO’s but they all only buy the shares once they hit the market, and some of them have specified times that they will buy the shares rather than at the first available time.

The most common IPO ETF that I hear frequently talked about is the Renaissance IPO ETF (IPO). I had hoped that if I bought shares of this ETF then I would actually be able to pull a quick one on the system and get in before the IPO’s hit the market…nope!

Turns out that IPO is simply just buying these same companies when they hit the market and then holding them for 2 years before cutting bait.

Below is a view of the top 10 holdings of IPO as of 2/2/21 from ETF.com:

I’m guessing that you have heard of a lot of these names before. Truthfully, I’m a bit surprised to not see some of the big new names on here like Airbnb, Snowflake, DoorDash, etc., but maybe those companies are just a bit too old and this ETF is choosing now to get too wrapped up in those stocks at the very beginning.

Now, as we all want to know – how does it fare against a common benchmark like the S&P 500?

Again, using ETF.com, I show the following performance:

Pretty much spot on with the S&P 500 over the last 5 years up until COVID-19 really hit in March of 2020. At that point, you see the two ETFs drop in tandem and then IPO just takes off like a rocket!

Now, I’m not terribly surprised because growth stocks have been on a tear lately, but that doesn’t mean it’s going to continue in the future. Truthfully, it’s hard to really judge the performance of this ETF while we’re still in a bull market despite being in a global pandemic.

Is that weird to read? It was weird to write. The stock market is at all-time highs and we’re still in the middle of a global pandemic. Just pure insanity.

But that’s neither here nor there, because we still have SPAC’s to talk about!

Now, can you actually invest in SPAC’s? Heck yes!

Remember how I talked about Chamath earlier? Well, you can actually invest in some of the SPAC’s that he has on the market such as IPOE and IPOF.

IPOE is the SPAC that is rumored to be taking over SoFi and just look at how it has performed since it went public on 11/30/20:

The company is up nearly 150% and remember – it literally does nothing. Like absolutely nothing at all. You’re just hoping that it actually acquires a company with some sort of financial metrics at all.

IPOF on the other hand is another SPAC of Chamath’s but the difference here is that there are zero public rumors about the acquisition target for this SPAC. AKA even less info than IPOE, but who cares? This one is up only 50% in two months since becoming public:

50% in two months? Psh. That’s chump change.

Obvious sarcasm. Just mind-blowing stuff right here.

Of course, there are some SPAC ETF’s as well (why wouldn’t there be?) that you can use if you want to avoid picking an individual stock. Normally you’d choose an ETF over an individual stock because you’re risk averse, but if you’re investing in a SPAC then you can just throw that excuse out the window.

One of these SPAC ETF’s is the Defiance Next Gen SPAC Derived ETF, trading under the ticker of SPAK. SPAK tries to accomplish the following per ETF.com. 

Unfortunately, this ETF is so new that it doesn’t even have a year of data that we can compare vs. the S&P 500:

You’ve probably heard of some of their top 10 holdings, primarily the top 2 (both of which are speculative investments of mine):

I haven’t heard of most of these before, so it would still be a pretty major risk for me to invest in.

So, at the end of the day, can you invest in IPO’s?

YES!

Just has to technically be after the IPO has occurred and they’re trading to the public.

And can you invest in SPAC’s?

YES!

But you’re either going to invest in a SPAC ticker with essentially zero insight about the company that you might own or you’re going to buy some random ETF that doesn’t seem very helpful either.

So, what should you do? If you want to throw a little bit of money at some of these as pure speculative investments, I have no issues with that. It’s good to have some crazy speculation in your portfolio as long as you recognize, and are comfortable with, the fact that it might literally go to $0.

If you’re not comfortable with that, then you should’ve never even opened this article!

Instead, focus on finding companies that are well under their intrinsic value and invest with a margin of safety – that’s how you become a great stock picker!