Uber and Lyft are two big companies that made a huge splash with their IPOs recently, but it remains to be seen whether either will become profitable.
Both have posted billions in losses so far and it doesn’t seem like that will change any time soon.
With that in mind, it makes you wonder why so many investors pay tons of money to invest in IPOs as soon as they can. I mean, what’s the big deal?
In today’s show, I’m going to dive deep into this topic and provide some academic data that sheds light on IPOs. Once you know more about them and how they’ve performed historically, you may come to see IPOs for what they are — an exciting event that will more than likely cost you money if you get involved.
Listen to today’s podcast episode by clicking on the links below:
How to Listen to Today’s Episode
Episode Links & Resources:
- 👉 Get Your One-Time Retirement Plan
- IPO Data {Warrington College of Business, University of Florida}
- True Price of an Uber Ride in Question {Blog Post}
Should You Get in on the Next Big IPO?
If you’ve been paying attention to investing news over the last few years, you’re probably aware that several huge companies including Uber and Lyft have moved forward with an IPO. Whenever this happens, this means that a private company that was previously out of reach for regular investors decides to take their company public. And, once an IPO is underway, regular investors like you and me can buy and trade their stock.
Uber was an especially interesting IPO to watch, since the company has become such an integral part of American life. The rideshare firm was originally funded by a well-known venture capital firm known as Benchmark — and yes, that’s the same one that funded Twitter, Zillow, and several other popular technology start-ups. Uber was also funded by Fidelity Investments, and this combination of initial funds helped the company get off the ground.
What’s interesting about Uber is that they’re not profitable — and they never have been! In fact, Uber reported $1.8 billion in losses in 2018. It’s hard to imagine why anyone would want to invest in a company that is bleeding money despite its dominance of the market, yet that’s exactly what is happening.
Then again, Uber is still a “young” company, so they have plenty of time to turn things around. Will they? That’s an entirely different story, but nobody knows for sure.
Why Do Companies Go Public?
If you’re a fan of the ABC show Shark Tank like I am, you have probably heard all the sharks talk about the importance of an “exit strategy”. What this means is, they prefer to invest in ideas or products they can eventually unload somehow.
Here’s a good example: The founder of Ring, a home security company, was on Shark Tank and didn’t get a deal. Eventually though, Richard Branson caught wind of the company and got in as an early investor. In late 2018, Amazon.com purchased Ring for $1 billion dollars. Now, that’s an exit if I’ve ever seen one.
Another type of exit is an IPO, which involves taking your company public so that regular investors can buy in. But, why do companies go public? There are a few different reasons. First, big companies require cash flow to expand and build systems so they can grow their market share, and going public can provide them with funds.
Second, IPOs allow the owners and the initial private investors of a company to finally cash in all the hard work and risk they put in.
Keep in mind that many beginning investors stand to make millions overnight when a company goes public, and this is a huge incentive.
Historical Returns of IPOs
If you purchased Lyft stock during the IPO, you’ve lost about 34% of your investment. Uber stock, on the other hand, is down around 18% since it went public.
That sounds awful, but that doesn’t mean either stock is a poor long-term investment. Remember that both Uber and Lyft are on short timelines, so you never know what will happen. Also, keep in mind that an initial drop doesn’t mean prices will stay low forever.
A good example of this is Facebook stock, which dropped 50% after their IPO but now trades at over $185. In May of 2012, or seven years ago, you could buy stock in Facebook for a little over $38 per share.
But there is some real data on IPOs that provides more insight than just looking at the biggest public offerings of the last few years. Professor Jay Ritter from the University of Florida has studied IPOs for years and he makes a variety of information public on his website.
Here are a few of the juiciest stats:
- From 1980 to 2015, the average first-day return for an IPO worked out to 18%.
- In addition, data shows that returns are positive on the first day of an IPO more than 70% of the time.
However, these numbers may not be entirely representative of what you can expect. Ben Carlson, who blogs at A Wealth of Common Sense, points out that the average first day return is likely skewed by the dot com bubble that took hold in the ’90s. If you skip over the crazy dot com years, the average returns would be much lower.
Also, get this: According to Ritter’s data, the average three-year return for IPOs lagged the market by about 18%. This means you would have been better off investing in low-cost broad-based index funds versus an IPO if you were investing over a three-year timeline.
Should You Invest in an IPO?
You might think investing in a big company you love is exciting, but I personally think it’s overrated. Even IPOs held for the long-term under-perform the markets, and there is plenty of academic data to back this assertion up.
With that being said, I’m a big fan of cowboy accounts — or “fun money” accounts that make up less than 5% of your portfolio. You can consider using a cowboy account to buy individual stocks, Bitcoin, or an IPO — but only if you have a concrete financial plan and an investment policy statement.
In other words, don’t buy into an IPO just because your neighbor, friend, or colleague says they think it’s a good idea. And don’t buy stock because you have a severe case of FOMO — fear of missing out.
The best investment plan is a boring one and that’s why, when it comes to IPOs, I’m sitting out.
Episode Transcription
Should You Get in on the Next Big IPO Stock?
Taylor Schulte: Welcome to the Stay Wealthy Podcast. I'm your host, Taylor Schulte, and today we are talking about the wonderful world of IPOs, also known as initial public offerings.
But first, I want to quickly thank everyone for all the kind messages and feedback I've received over the last few weeks. There are over 700,000 podcasts in iTunes with business podcasts just like this one being the second most popular genre, and I learned from a listener this week that we recently cracked the top 200 in iTunes, which is just crazy to me.
This podcast is, as you guys know, a labor of love, and it just feels good to see my hard work pay off and just get some recognition and know that people are finding this information helpful and valuable.
So thank you for the support. Keep the questions and messages and feedback coming. I read and respond to every email, even the one that said, Taylor, you don't know what you're talking about and you should shut this podcast down. Even that one, I even responded to that email.
So please keep the messages coming and thank you again for all the support. Okay, with that out of the way by now, you have likely caught wind of the Uber and Lyft IPOs. If not, the short story is that these two companies were private for a really long time, meaning the general public, you and me could not invest in them, and now they're publicly traded, which means anyone and everyone can own a piece of these companies.
Uber in particular was initially funded by a venture capital firm called Benchmark, and Benchmark is a very well-known VC firm who has previously funded companies that we all know by name, companies like Twitter, Dropbox, Zillow, and a bunch more. Uber was also funded by a mutual fund firm called Fidelity Investments.
So they took on private money, private investments in the beginning, same with Lyft, same with a lot of these companies to help get them off the ground.
Now, given all the headlines around these two IPOs recently, I wanted to do an episode on the topic and really talk about four things.
One, why companies like Uber, Lyft, Snapchat, and all the others, you know, why they start out as private companies and then make this decision to go public.
Number two, I want to talk about a brief history of the historical investment returns of IPOs.
Number three, I want to try to answer the question, should mom-and-pop investors, people like you and me, should we be investing our hard-earned money in these really exciting companies?
And then lastly, I just want to share some thoughts on Uber and Lyft and where I think things might go from here. For all the resources and links mentioned in this episode, visit youstaywealthy.com/45.
I don't know about you, but I am uber-excited about this episode. Let me just lift up my microphone a little. Alright, let's get into it.
If you're a Shark Tank addict like me, you've likely heard the sharks say something along the lines of, the only way I'll get my money back is if there's an exit. And you might remember, the founder of Ring Ring is that fancy video doorbell that a lot of us have now.
Well, the founder of Ring was initially on Shark Tank and he didn't get a deal, but Richard Branson shortly caught wind of it, invested some money, and then the company, as we all know now, was eventually sold to Amazon for $1 billion. So that was their exit, and everyone enjoyed a nice payday except for the Sharks.
Of course, selling to another company like Amazon or being acquired is one version of an exit. Another option is an IPO, taking your private company to the public markets and giving them a piece of the ownership. I mean, there's a lot of reasons, but there are really two main reasons that a company will go public.
The first reason is they require a lot more money to expand. So taking investments, taking money from the public will allow them to do this expansion to buy more equipment, invest in infrastructure, or maybe even pay off debt. So that's one reason is they need more money.
Two, an IPO allows the owners and the initial private investors, those venture capital firms to finally cash in on all their hard work and all the risk that they took. The owners and the private investors in the beginning often stand to make millions of dollars when the company goes public.
As you all know very well by now, IPOs typically come with a lot of hype. The media gives them a lot of coverage. They make headlines in the newspapers for the first time. Investors like you and me can invest our hard-earned money into these exciting companies that we've been watching and using and reading about for years, and it feels like a great opportunity.
Unfortunately, it doesn't always work out in the favor for the mom-and-pop investors. For instance, if you bought Lyft stock at its IPO, you've lost as of this recording, you've lost about 34% of your investment, and Uber is not too far away. Uber is down about 18% since hitting the public markets.
Now we're talking about a really short time period here, so it's difficult to draw any real conclusion. Remember, Facebook stock when it went public dropped over 50% post-IPO, all the way down to about $17 per share. And if you look at it now as if today, it trades at about $186 per share.
So just because there's a short-term drop after a company goes public isn't always indicative of future returns, but even including Facebook, we're only talking about a short time period for all three of these companies. And more importantly, we're only talking about three companies, which is a really small sample size.
Thankfully, there's a guy out there, a professor, his name is Jay Ritter, and he's a professor at the University of Florida, and he's an IPO expert, and he has a ton of historical data on initial public offerings, and Jay is really nice to make this information public and even update it annually on his website.
So if you're interested in diving into some of this stuff deeper, I'll link to his website in the show notes. But according to his site, from 1980 to 2015, the average first day return for an IPO is a massive 18%. So on average, the very first day a company goes public, the return has been a positive 18%.
In addition, his data shows that returns are positive on the first day more than 70% of the time, which is just really, really interesting. So that first day usually generates some really good returns and is usually positive.
However, if you stretch this out a little bit longer, the average three-year return, if you bought it at the IPO and you held it for three years, the average three-year buy and hold return lagged the market by about that same amount by about 18%.
In other words, holding these IPO stocks for three years would've returned about 18% less than if you would've just bought a broad-based stock index fund. Now in Jay's data, he uses the crisp value weighted index for his comparison, but I'm fairly confident that you'll find similar numbers if you use a different broad-based index, perhaps the S&P 500 or something even more broad based than that.
But Jay uses the crisp Valuated index in his data, Ben Carlson, who blogs at a Wealth of common Sense. He points out that this average first day return, yeah, it's huge. 18% is a big number, but he reminds us that this data is likely skewed by the.com bubble. If you invested in the nineties, these tech IPOs, these tech stocks were just skyrocketing. We all know how that ended.
So if you stripped out those years where we had these crazy tech companies just going through the roof, if you strip those out, the average first day returns would probably be much lower, but it is what it is. The tech bubble is part of history, and we're looking at historical data. So that's what we get.
Now, these are really exciting numbers. Aside from that three-year buy-and-hold number, that first day, the on average, you're likely going to have a positive return on the first day. It sounds like a good deal. Now, I want to point something out. The IPO numbers that we just talked about are assuming that you are able to get shares of the stock before that big first day pops, and very few investors are able to get in before that happens.
When the market opens interest in these really hot issue IPOs, especially the Ubers and Lyfts, these companies that we all use, it's not easy for small investors like us to get the shares that we want to get if we get any shares at all.
For example, there was an article that came out talking about Morgan Stanley and Morgan Stanley offered IPO shares to its private wealth management clients, but the minimum investment was $250,000. So you had to have a lot more money than that to risk $250,000 on an IPO.
Also, Morgan Stanley charged upwards of 2% to their clients just for this opportunity. So you had to have a lot of money, and then you had to pay a lot of money to get in. To make matters even worse, the shares are restricted. So Morgan's clients have to wait 180 days before they can sell the stock, and I just shared how poorly they're performing out of the gates here.
So you can imagine early investors in Uber and Lyft through Morgan Stanley, probably not too thrilled about this right now. And I don't mean to pick on Morgan. There was just an article that came out highlighting this deal. This is what happens across all the big brokerage firms when you purchase these IPO shares.
So to sum this all up, the investment banks, these big investment banks like Goldman Sachs and Morgan Stanley, they get paid huge bucks to take a company like Uber. Public companies like Uber will come to Goldman to help guide them through this process and take them public, and they get paid handsomely for that. Then these companies charge a hefty fee of their clients to go ahead and get in on the stock early, regardless of how the stock performs.
And then lastly, the owners of these private companies, the owners and early investors in Uber and Lyft, like I just shared, they get a really nice payday when they're finally able to cash in their shares and the public's able to buy in.
So there's a lot of winners here, but for the general public, for you and I, it's really a coin toss. It really depends on your time horizon, how lucky you are on the first day of trading your decision to invest in the IPO could make you look like a hero or it could leave you running from the markets and really never wanting to invest again. What we do know is that on average, holding IPOs for long periods of time underperform the broad indexes.
So should mom-and-pop investors put their hard-earned money in IPOs? In short, I personally think the costs and speculative nature of investing in IPOs, I think that all outweighs the benefit for us individual investors. I've shared numerous times on the podcast that academic data, real academic data supports investing in low-cost broad-base index fund versus trying to pick individual stocks or trying to time an IPO.
And since I'm a data nerd, that's what I'm going to stick with for my hard-earned money. Now, before you harp on me too quickly, if you're a longtime listener of the show, you might know that I'm a big fan of what we call cowboy accounts. And your cowboy account should represent less than 5% of your investible assets.
And this account is reserved for making fun speculative investments like buying individual stocks, dipping your toes in Bitcoin, or even getting in on the ground level of an IPO like Uber or Lyft or Snapchat or Facebook or any of these. This cowboy account allows you to scratch that itch, have some fun, participate in the markets.
You might learn a thing or two by getting your hands dirty and you're doing it without jeopardizing your financial plan. Speaking of your financial plan, it also likely makes sense that you have a concrete plan in place before you even think about investing in an IPO.
Your financial plan, and I've said this before, your financial plan is going to guide your investment policy statement, and everybody should have an investment policy statement. I don't care if you have a financial advisor or if you're managing your accounts on your own. Everyone should have an investment policy statement.
So your financial plan will guide your investment policy statement, and your investment policy statement will guide how your money is invested in the markets, even your cowboy accounts. Your investments really should not radically change unless your financial plan changes.
So just because your neighbor is buying shares of Uber or a friend or a family member, that doesn't necessarily mean that you should be buying it too. I personally don't own any shares of Uber or Lyft. I've never participated in an IPO and I really don't plan to.
But I'm really interested in watching these two companies in particular and watching from the sidelines to see how this all plays out, particularly because, I mean, Uber's really getting picked on lately, but Uber booked 3 billion in losses last year.
Yes, that's 3 billion in losses just last year. And this is the company, if you remember, you can Google the original Uber pitch deck. Uber originally pitched itself as profitable by design. That was their quote, profitable by design, and this company is not. And there's a lot of analysts and really smart people out there that don't think they will ever be profitable.
And if you're wondering, Lyft is not profitable either. They recently reported quarterly losses exceeding $1 billion, so we're talking big money here. And look, we can point to other companies that were not profitable that overcame that became profitable, and they turned out to be tremendous investment.
So again, we're dealing with a very small sample size here, but these are the companies making headlines right now. And so I wanted to talk about them. Keep in mind, there is no other reason why another company or several companies couldn't set up a computerized algorithm that matches rider on their smartphones with drivers who also have smartphones.
After all, this entire arrangement really is nothing more than a really nicely designed app. And yes, Uber and Lyft and some of the others out there, they have the brand recognition. They were first to market. But if you've done some reading lately, Google has some serious leverage over Uber.
In particular, it was recently released that Uber paid Google about $58 million between 2016 and 2018 just to use Google Maps. And then you might be saying, well, maybe they don't need to use Google Maps. Maybe they can use another map provider or they can develop their own mapping tool.
But in a recent filing, Uber actually came out and said that Google Maps their functionality was critical to its platform. And this is the quote the says, and this is from Uber. The quote says,
”We do not believe that an alternative mapping solution exists that can provide the global functionality that we require to offer our platform in all of the markets in which we operate.”
So Google Maps is critical to Uber's functionality. Now, in 2016 to 2018, they paid him $58 million. Maybe it doesn't sound like that much money, but it could certainly be a lot more in the future if Google starts to use this as leverage. And remember, it wasn't that long ago that you could open up the Google Maps application on your phone and you could book an Uber directly through Google Maps.
And if you've noticed lately that doesn't exist anymore, Google has stripped that away from them. I'm not sure why, I'm not about to speculate, but my whole point here is that there could be another company or several that come in to try and compete with Uber and Lyft.
So that's one thing that's going to be interesting to see play out. What might make Uber even less attractive is its somewhat contentious relationship with its drivers who, as we all know, provide a hundred percent of the actual service to the end customers.
And you might've seen a few weeks ago, thousands of Uber drivers across the country turned off their apps and went on this strike over pay and working conditions. Recently, Uber released a securities filing and stated that they reached an agreement with about 60,000 of its drivers, but get this, the total cost, including attorney's fees, was estimated to be between 150 million and $170 million.
So there's just a lot of money flowing out of Uber right now. Lastly, something I don't think everyone is aware of. It was reported back in 2015, and I don't think it's changed all that much today, but it was reported that Uber passengers us, the users of Uber, were only paying about 41% of the actual cost of their trips.
We were only paying a fraction of what it actually costs to take an Uber, the full cost, the full fare was being subsidized by these early investors, and it was essentially a marketing play.
They're essentially paying for customers by reducing the cost and making it more palatable for us to adopt and use their company and their platform, reducing that cost in the near term to try and get customers. I'll link to the article in the show notes if you're interested in reading more.
But what happens when they burn through all of their funding and we all start paying full fares to take an Uber? I'm not really sure. I don't know how my behavior is going to change. I'll probably use these ride sharing apps a little bit less. I'll probably start to be a little bit more conscious, especially if the number is much, much higher than what it is today.
Now, some say there is some research here. Some say that there's room to actually raise prices, so maybe they know what they're doing here, but there's some studies done in the cab industry, and the research showed that historically when cabs raise their fares by 20%, that they only lost about four or 5% of their customers.
So there might actually be room to raise prices. Sure, maybe not everybody's going to use Uber, but they're only going to lose a small number of their users and they're going to get a higher price. So maybe it all evens out in the end.
But regardless, there are a lot of question marks here, and there's a lot of risk, rightfully so. These are very new young companies, but with risk comes opportunity. The venture capital firms like Benchmark and others, they'll be the first to tell you that they're happy If one out of every 10 of their deals is a success, they're okay with nine of their deals falling flat on their face as long as one of them knocks it out of the park, that reward is going to make up for the rest.
And they understand this. This is the business that they're in. They understand their risk and they're willing to take it, but I am personally just not interested in gambling with my money and taking this quote ride.
There's too many unknowns for me, and I would rather be a speculator on the sidelines and put my money to work in other places that I see perceived less risk. And for those reasons, I'm out.
Thank you as always for listening. Again, you can grab all the links and resources mentioned in this episode by going to youstaywealthy.com/45. I'll see you in two weeks.
Episode Disclaimer: This podcast is for informational and entertainment purposes only and should not be relied upon as a basis for investment decisions. This podcast is not engaged in rendering legal, financial, or other professional services.