The Truth About IPO Investing

TM Editors' note: This article discusses a penny stock and/or microcap. Such stocks are easily manipulated; do your own careful due diligence.

The Truth About IPO Investing

When most companies go public, they are somewhat mature. They typically have earnings and cash flow. Tech company initial public offerings, or IPOs, are a bit different, however. These companies are often not yet profitable. And biotech IPOs are a special animal altogether. Not only are the companies not usually profitable, but most of the time, they don’t even have a product on the market yet.

For example, in May, Acelyrin (SLRN) raised $540 million in an IPO. The stock is up more than 33% since then. The company’s lead drug is being studied in a variety of conditions, including psoriasis and inflammation in the eye. The drug is in Phase 2 trials.

When things work for these small-cap biotechs, it can be wildly lucrative.

Take Pharmacyclics, for example. The company, focused on treating cancer, went public in 1995, offering 2.15 million shares at $12 per share and raising a little more than $25 million.

It wasn’t until 14 years later that Pharmacyclics conducted its first human trials of ibrutinib, which went on to become the company’s first Food and Drug Administration-approved product in 2014 and a blockbuster drug. The following year, AbbVie (ABBV) acquired Pharmacyclics for $21 billion.

If you had bought shares of Pharmacyclics on Dec. 7, 2009, after the company presented positive results from a Phase 1 study, you would’ve paid $2.35 per share. A little more than five years later, the company announced it was being acquired and you could have sold it for $230.48 per share.

Of course, you would have had to hold on to a very speculative stock for more than five years to do so. But even if you had sold pieces of the position off over the years and were left with a fraction of the original position, you would have done extremely well.

Medivation is another great example. Medivation IPO’d on Dec. 20, 2004, at $1.55 per share. On Aug. 22, 2016, shares peaked at $326.00. That means investors who got into Medivation at the IPO price of $1.55 a share could have seen a staggering 20,932% increase on their holdings.

Pharmacyclics and Medivation are the exceptions, though, not the rule. Most early-stage biotech companies never have that kind of success. Many never get a drug on the market. In fact, a drug entering human trials has about only a 1 in 10 chance of being approved. So it makes sense that the rewards need to be large to take on that kind of risk.

Since these stocks can be very speculative, there are a few things you can do to lower your risk.

  1. Place a trailing stop. I recommend using a 25% trailing stop on most trading positions. That means you raise the stop as the stock moves higher. That can help limit your losses if things go wrong.
  2. Position size accordingly. I recommend never putting more than 4% of your risk capital into any one position. That way, if you get stopped out for a 25% loss, you’ve lost only 1% of your total capital.
  3. Keep an eye on catalysts. Small biotech stocks don’t often react to earnings reports as most stocks do. But they can move after the release of clinical trial data or a presentation at an important conference.
  4. Be aware of when data is coming out or when a company is scheduled to present at a conference so you can pay attention to how the stock responds to news. Companies will usually issue press releases mentioning the dates they’re presenting at conferences. Specific dates for clinical data releases are usually not announced ahead of time. Rather, companies will give a rough time frame for the data release, such as “the first quarter of the year.”
  5. If you invest in IPOs, do it with a company that has a good track record. The venture capital firm that helped take Medivation public in 2004, MDB Capital Holdings, has a long, successful track record of helping biotech companies IPO and helping them thrive afterward -- like Pulse Biosciences (PLSE) (1,046%), Cue Biopharma (CUE) (325%), Provention Bio (525%), and many others. Clearly, MDB knows what to look for in a private biotech company.

You can hit some big home runs in the biotech sector, but you need to manage your risk when trading these stocks. If you handle your risk properly, you’ll be able to take more big swings and hit one of those portfolio-altering gains.

More By This Author:

ARCC Stock: Did This 10% Yielder Get Safer?
Three Lessons For Investing In Biotech Companies
How To Invest In The Healthcare Sector

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