What Is an IPO, and Should You Ever Buy One?

If you've ever wondered what an IPO is and what the terms are that are being thrown around, I'm here to answer those questions for you in very simple terms. IPOs are something every public company goes through, so this is something for any investor to know even if buying IPOs is not for you. So, let's start with the definition of an IPO. It is the initial public offering of a stock. This is the first time that a company's shares are traded publicly. Most of the companies in the world today are private. They're not publicly traded on a day-to-day basis. Some of those are venture-backed or owned by private equity firms, but a lot of them are just owned by individuals, small businesses that you may know in your city or town. You can't go out and buy shares of Chick-fil-A or Raising Cane's, for example, companies that you may know. But, you can buy public companies. So, this is just simply the first time those shares are offered to the public. So, the first question is why are these companies going public? Historically, this was a way to raise capital. For example, Walmart was able to raise capital to grow its footprint and expand not only nationally, but also internationally as well. Alphabet did the same. They spent billions of dollars building out their infrastructure, and they did most of that while being a public company. Companies use public markets because this is the largest pool of assets and liquidity that they're going to have available. Private equity and venture capital firms just simply aren't as big as public markets. But, as VC firms and PE firms have gotten bigger, that need for capital hasn't been quite as acute, and companies have stayed private longer. So, you can think about a company like Stripe, who has stayed private and raised billions and billions of dollars because they just simply don't want to go public. These days, companies don't have to go public because there are other options for funding their businesses long-term. That's why recently we've heard more about public offerings being an exit, an exit for founders and an exit for investors. When you look at IPOs like SpaceX or Anthropic or OpenAI. These are ways for venture investors or angel investors to get money out of these companies. It's not easy to sell potentially a multi-billion-dollar position on private markets, but if you're a publicly traded company, now you have the liquidity to sell those shares at any time that you want. So, going public can be a great way for companies and investors to unlock the funds and the wealth that they built in these companies. There's no one reason why companies IPO, but these are just a few of the reasons that may be behind it. So, what do you need to know about an IPO? Let's start with the business. The biggest document that you need to know if looking at an IPO is what's called the S-1. The S-1 is a filing with the SEC that lays out everything that you need to know about a company. The company's income statement, balance sheet, and statement of cash flows. But, it also says, "Hey, here's what our business model is. How Here's how we generate revenue, and here's how we see the business unfolding in the future." This is a big document, but it can be really important for investors. So, for example, this is SpaceX's S-1 dated May 20th, 2026. Company went public a couple of weeks later, but this tells you everything not only about the company, but also the offering itself. In this document, you can see that there's going to be two class types of stock, class A shares and class B shares. Class B shares are going to hold 10 votes per class A share. This is how Elon Musk keeps control of SpaceX. This is also where you see things like the total addressable market that SpaceX sees for itself, $370 billion in space-enabled solutions. But, the huge opportunity is artificial intelligence. Probably more importantly is the actual financials. How much revenue is the company generating? So, SpaceX, for example, in 2025 generated $18.7 billion worth of revenue and lost almost $5 billion on the bottom line. We also learned a lot about what actually drives the business. Segment income was negative for the space segment in 2025, just barely made a profit in 2024. Connectivity is actually where the money was being made. $4.4 billion in operating income, and artificial intelligence was by far where the biggest spend was, and also the biggest losses. $6.4 billion worth of losses. And then just 3 months, $2.5 billion in operating losses in the first 3 months of 2026. So this S-1 is going to give you all of the financial information that you're typically going to get from quarterly reports. Very important to understand not only management's vision of the future, but also what they've actually reported in the past. The S-1 is also going to tell you how much a company is raising or planning to raise. Those details only come out a few hours before the IPO actually happens when the IPO is actually priced. But you can determine based on that IPO price exactly how much the company is raising, and they are going to tell you what those funds are going to be used for. Are they going to be using it to pay down debt? Are they going to be using it to fund growth or acquisitions? Those answers are going to be in the S-1. You're also going to see how much are insiders selling, and importantly, what is the valuation? Based on the stock price and the number of shares outstanding, you're going to learn what the market cap of the company is, and then you're going to be able to determine things like the price-to-sales multiple, the price-to-earnings multiple, price-to-free cash flow, all the things that we think about with publicly traded companies. So now that you know what an IPO is, what documents you need to look at to learn about a company, are IPOs worth investing in? That answer depends on the company, the price, and your risk profile as an investor. But there are some things to know. Short-term, IPOs typically get a pop on their first day. This is because bankers have an incentive to underprice the IPO. Remember, this is the initial public offering. So these initial shares have to go to someone. Those go through investment banks, and then there those investment banks then decide where they're going to allocate those shares. If someone's going to allocate money to an IPO because the bank wants them to buy it, that bank has an incentive to underprice that IPO. That's why we typically get a pop on the first day. A fall in the stock often looks like a failure, too. So, there's a lot of incentives short-term to have a really good day on the first day, even if that doesn't necessarily hold, which is typically what happens medium-term. According to LPL Financial, 54% of IPOs fell in their first year of trading, and the average drawdown from peak to the bottom was about 50%. So, patience is okay here. There's no rush into an IPO as an investor, especially if you have a long-term view of the company. We can even see that with SpaceX recently. The IPO price was $135 per share. By the end of the first day of trading, shares were nearly $200. Second day, closed over $200. But, over the next couple of months, shares fell significantly and are still only trading at a slight premium to that IPO price today. And sometimes patience pays off for investors. This is Robinhood's IPO. You can see the shares popped on their first couple of days of trading, but then over the next couple of years, they really struggled down 80 to 90%. You see the same thing with Rivian. Rivian popped when it went public, but is actually down significantly since then. So, patience can be key for investors looking at IPOs. So, at the end of the day, an IPO is simply the first day that a company is traded in public markets, but is hardly the end of the company's story. Many companies are public for decades and can be long-term winners for investors. That's what I'm foolish investors for. So, if you're looking at IPOs, there are three keys that you need to think about. Know what you're buying and why someone else is selling. Remember, this is an exit for some investors and for some insiders, as well. To know what you're buying, look at that S-1 document. That is going to have a lot of information that's going to really unearth what that company is doing and how they see that future unfolding. You also need to know what you're paying. What's the market cap and the valuation of the company going to be after the IPO? This isn't always obvious because sometimes there are lockup periods, sometimes there are warrants or converts. So, look for those little details in S-1 that will tell you how many shares will ultimately be outstanding and prepare for volatility. Like I showed, the first day is often pretty good for investors, but most retail investors are not buying at that IPO price. They're buying when the shares actually hit the public market and you get that significant pop sometimes. But, it's okay to be patient, to put IPO companies on your watch list for a while and then buy opportunistically if shares do fall as they often do in the first year or two of trading. Some of the best companies in the world, like Nvidia, Amazon, Meta Platforms went through massive drawdowns after their IPO. For patient investors, those can be great buying opportunities. So, don't be afraid of IPOs as an investor, but don't fall into FOMO, either. If you want more from The Motley Fool, check out our Epic portfolio. This is a complete, ready-to-invest portfolio with The Motley Fool's real money behind it. You can find that at fool.com/epic-50. Thanks for watching, everybody. We'll see you here next time.