The Square IPO will price this Wednesday, Nov. 18. The deal is one of the most anticipated tech IPOs of the year. Square plans to raise up to $351 million by selling 27 million shares for $11 to $13 each.
With the company hitting the market this week, investors are wondering if investing in Square stock is a smart decision.
That's why we developed a three-step strategy for those thinking about investing in Square stock.
But first, here's what investors need to know about the Square IPO...
Founded in 2009 by Jack Dorsey and Jim McKelvey, Square Inc. (NYSE: SQ) provides a mobile payment service for phones and tablets. Its primary product is the Square Reader software, which plugs into a standard headset jack on mobile devices and lets people take credit and debit card payments. Each Reader costs about $10.
The Square IPO comes less than two months after CEO Jack Dorsey became permanent CEO of Twitter Inc. (NYSE: TWTR). Dorsey will be dividing his time and attention between the two tech companies. His dual leadership with his two "children" leaves investors wondering if he'll be able to head two publicly traded companies.
In fact, Dorsey himself was listed as a risk in the Square IPO filing...
"This may at times adversely affect [Dorsey's] ability to devote time, attention, and effort to Square," the filing said.
And that's not the only risk facing SQ stock. The company is also not profitable...
During the first half of 2015, Square earned $560.6 million in revenue, up 51% from the first half of last year. About 11% of this year's sales have come from its partnership with Starbucks Corp. (Nasdaq: SBUX), which has been selling Square Readers at U.S. locations since 2013.
However, Square has actually lost $71 million since the partnership started. Starbucks has ended up accounting for 21% of Square's transaction costs this year. The firm is already in a $77.6 million hole this year and stated in the IPO filing it "may not achieve or maintain profitability."
Another challenge the firm faces is the volatile IPO market. There have been only 18 tech IPOs this year - the lowest number of tech deals since 2008. According to Renaissance Capital, a manager of IPO-focused ETFs, all 2015 IPOs have seen an average decline of 4.3%.
IPO investing is dangerous even when the sector is booming. That's because traders who aren't hedge fund managers or Wall Street bankers can see huge losses if they don't follow a diligent strategy.
"IPOs are little more than a get-rich-quick scheme that's so heavily stacked against you that it makes the house odds in Vegas seem downright conservative," said Money Morning Chief Investment Strategist Keith Fitz-Gerald. "I say that because you are literally the last in a long line of people who are going to profit from the IPO process."
Without a proper strategy for investing in IPOs, retail investors can get burned. Here's the safest strategy for investing in Square stock...
[mmpazkzone name="in-story" network="9794" site="307044" id="137008" type="4"]
Investing in Square Stock Rule No. 1: Wait until the Square IPO lock-up period is over
The best way to profit from a new stock is to hold off until the frenzy settles down and the IPO lock-up period ends. The IPO lock-up period is the stretch of time after a company goes public in which early investors, like founders and venture capitalists, can't sell their shares of the stock. It can last anywhere from 90 to 180 days after the company hits the market.
Early Square IPO investors are subject to a 180-day lock-up period. Since it begins on the date of the IPO filing, the lock-up will end on April 11, 2016. That's the perfect amount of time to consider the company's growth and avoid much of the early volatility new stocks experience.
Investing in Square Stock Rule No. 2: Make Square prove it's worth your money
Before buying a new stock, you'll also want to wait for a few quarterly earnings reports to come out.
One horrible earnings report can send a stock plunging. Etsy Inc. (Nasdaq: ETSY) went public in April and reported a huge loss of $36.6 million in its first earnings report. Shares responded by falling more than 19%. The numbers reflected how far Etsy is from becoming profitable.
With mounting losses and no profits in sight, Square could head down the same path as Etsy. The only way to determine that is to wait for at least three quarterly earnings reports to come out.
"IPO hype is based on what 'could be,' not what 'is,'" Fitz-Gerald said. "Many times management cannot make the jump, and you do not want to pay the price for finding out which is which."
Investing in Square Stock Rule No. 3: Use lowball orders
A lowball order is an offer that's far below the fair value of a stock. It's often used to gauge the seller's expectations for the value of the stock. Placing a lowball order means you are deliberately offering a very low price to appeal to sellers who want to get rid of their shares quickly. If they agree, they'll sell their shares to you at your determined price.
Lowball orders are perfect for new stocks like Square because they give you the power to name the price. It's always safer for your money to set the price you want and have the market come to you.
They also prevent you from chasing a risky trade, which can be tempting when a hot IPO hits the market.
"Temptation is the most powerful of all emotions, which is why Wall Street hypes IPOs the way they do," said Fitz-Gerald.
Alex McGuire is an associate editor for Money Morning who writes about upcoming IPOs. Follow him on Twitter for the biggest news on the Square IPO.
Like us on Facebook: Money Morning
What Does an IPO Underwriter Do? The underwriter is paramount to a new stock's success. But many investors have no idea what exactly an underwriter does. Here's a breakdown of what an underwriter is - and why they pulled in nearly $10 billion last year...
