IPO market heats up again but here’s why they might not make great investment

With the IPO markets running hot again, it’s a good idea to remind investors why buying into newly public companies is not always such a great idea.

Yesterday, two of the hottest IPOs came to the market, delivering big gains:

• Toast (NYSE:TOST), the restaurant technology provider, is up 56% — now valued at $31B.
• Freshworks (NASDAQ:FRSH), the customer service software provider, is up 32% — now valued at $13.5B.

Both are significantly higher than their IPO price but who benefited from their big gains? Early investors and institutional investors allocated stock upon these companies going public.

Once these companies hit the market and early investors net their big gains, retail investors are left with sloppy seconds. The biggest reason to avoid companies right after going public:

• On average, US tech IPOs underperform 5-6 months after going public — often when insiders are allowed to sell their shares.
• Valuation matters when it comes to picking stocks and the most hyped companies are often overpriced upon going public.

This is the “average” so investors can find outliers that perform well. But not all companies going public are the same — especially in the method they choose to do so. Companies that go public via direct listings outperform the market (ELI5: What are direct listings?)

Warby Parker is expected to go public via direct listing next week on Sept. 29 — and it’ll be interesting to see whether it can continue this trend.