Square Inc. (NYSE: SQ) stock starts trading on Thursday, Nov. 19. The Square IPO plans to raise $324 million by selling 27 million shares at an $11 to $13 price range. After the deal, the Square IPO valuation will be roughly $4.2 billion.
Some investors believe Square's innovative payment technology makes SQ stock a good investment. Others view CEO Jack Dorsey's dual leadership of both Square and Twitter Inc. (NYSE: TWTR) as a hindrance to future profitability.
In fact, the company openly admitted it may never turn a profit. It posted $154.1 million in net losses in 2014 and $77.6 million during the first half of 2015.
"Our business has generated net losses, and we intend to continue to invest substantially in our business," the Square IPO filing said. "Thus, we may not achieve or maintain profitability."
So how is an unprofitable company like Square valued at $4.2 billion? It's because the company is fueled by speculation...
The inflated Square IPO valuation puts the company among the "unicorns" - Silicon Valley's term for tech startups worth $1 billion or more. Many of these unicorns are companies with valuations they can never realistically live up to. That's because they're built on hype rather than growth figures like sales, revenue, and profits.
The only way unicorns can keep their valuations from getting slashed is by never actually going public.
"The nose-bleed valuations have put startups like Snapchat, Pinterest, and Airbnb in a pickle," said Sam Hamadeh, founder of research firm Privco, to MarketWatch. "[They] must continue to put off their IPOs, while they try to 'grow into the valuation' and pray they can IPO in the near future at a nice return to investors."
That happened with Square. After the company filed with the U.S. Securities and Exchange Commission to go public, the Square IPO valuation became $4.2 billion. That's significantly lower than the $6 billion valuation it received during its latest round of funding.
So that inflated valuation is a major concern for investors as the IPO approaches. And it's just one reason why you should avoid Square stock after the IPO.
Here are two more reasons why SQ stock is a dangerous addition to your portfolio...
The first reason you should avoid Square stock is the nature of the IPO market.
You see, IPOs only benefit institutional investors willing to buy thousands of shares before the stock hits the market. These "VIPs" send the stock soaring on its first day, which leads retail investors to think they can capture most of these profits if they jump in right away.
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But when retail investors jump in on the first day, the stock has already soared. So retail investors are buying in at an inflated first-day price. They're also missing out on the gains the Wall Street insiders already snagged.
When the price settles back down following the IPO frenzy, many of the retail investors who got in late are looking at a loss. This disadvantage can cause massive losses for traders like us who aren't hedge fund managers or investment bankers.
The second reason to avoid the Square IPO is the volatility in the IPO market right now. According to Renaissance Capital, a manager of IPO-focused ETFs, all 2015 IPOs have seen an average decline of 4.2% from their offer price. There have only been 18 tech IPOs this year - the lowest number of tech deals since 2008.
We will be providing coverage of the Square IPO leading up to its first day of trading. Follow us on Twitter for all of the biggest news updates.
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Square Isn't the Only Big IPO Next Week... Match Group, which owns dating services Match.com and Tinder, is also set to go public on Nov. 19. The deal is one of the most highly anticipated IPOs of the quarter. That's because Match Group boasts one quality that's uncommon among tech IPOs...
