Anthony Speciale Stock Market Analyst

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Why These Two Hot IPO Stocks are at Risk of Turning Toxic

There are a lot of folks out there who get really excited about and follow the initial public offering (IPO) market closely. But most of the time, you and I never get shares in these IPOs because we’re not the big players with the right connections.

IPO shares, especially the hot deals, tend to go to the biggest clients. Sure, it’s not fair, but it’s just kind of how it is. But a lot of folks love to trade these things in the aftermarket once they start trading, and you can get some wild swings.

If it’s a hot offering that’s been going up, the stock tends to get overvalued very quickly, and there’s something out there that can make these stocks absolutely toxic to your portfolio. You just don’t want them in there because they can do long-term damage to the value of your account.

What we need to be aware of is the share unlock date. When an IPO is done, most insiders and large shareholders are legally restricted from selling their shares for a specified period of time. The large blocks of shares are usually restricted for about six months from the IPO data before insiders can sell those shares.

So, it’s important to know the dates when shares unlock, because there is going to be a lot of volume coming into the market. The insiders aren’t going to sell all of their stock, but they will sell some, as it’s their first chance to monetize their personal holdings of the company they built.

This becomes a liquidity issue for the market to deal with, and the chances for the stock to move lower are pretty high most of the time. With that in mind, let’s take a look at a couple of stocks with share unlocks on the horizon that we need to be aware of.

DLocal Limited

First up is DLocal Limited (DLO). I actually really love this business, and if it was available at the right price, I would like to be a long-term owner of this company.
Based in Uruguay, they are a payment processor that’s helping some of the largest e-commerce companies in the world do business in about 20 emerging markets around the world by acting as their local payment provider. It’s a good business with good growth prospects.

Now, they’ve already done a secondary offering after having a very successful IPO. And that secondary put some pressure on the shares, and while the third-quarter earnings were strong, the guidance wasn’t what Wall Street was looking for. So, the shares have come down a bit recently.

And on Nov. 30, 263 million shares are going to unlock and be available for sale. There’s a lot of venture capital money in this stock, and I expect to see them ring the cash register, take some profits and get their money off of the table. And you’re going to see some of the insiders begin to take some cash and put it other places besides in the company.

This is going to be a liquidity issue that can push the stock down. And truthfully, it needs to go down, as it’s trading at 113 times what the analysts are hoping and praying they’ll make in 2020. It’s also at 86 times sales. Nothing good happens at 86 times sales!

So, the stock is ridiculously overpriced, there are 263 million shares coming available for sale and that is a potentially toxic combination.

KnowBe4, Inc.

My second potentially toxic stock is KnowBe4, Inc. (KNBE), which does cybersecurity awareness training. They’ve got some email training programs, and what they’re looking for is cybersecurity weaknesses. They want to figure out where the security holes in a business are and train employees how to deal with them.

Again, this is not a terrible business. However, the IPO has been red hot, and the stock is trading at 254 times earnings and 18.8 times sales. That’s too high for almost any business on the planet, as far as I’m concerned.

Now, we’ve seen a bit of selling of some previously unlocked stock based on earnings conditions that were met, but those were small pieces of the pie. And now, 140.9 million shares were just unlocked on Nov. 9, so there’s going to be a lot of stock hitting the market by insiders and their venture capital backers.

Again, this is not a bad company, but it is grossly overpriced with a lot of stock coming onto the market. So, this could quickly develop into a toxic situation that creates a permanent loss of capital in your portfolio.

If you’re going to be trading IPO shares in the first six months after the IPO, you need to know when and how many shares can be unlocked based on earnings conditions and that six-month rule. It’s important because the selling is going to come into the market, and it can trash the stock, especially if it’s trading at an excessive multiple of sales and earnings.

We want to avoid toxic stocks in all situations, and IPOs with upcoming unlocks have the potential to be incredibly toxic.