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This video was recorded on Oct. 4, 2019.

Dylan Lewis: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It’s Friday, Oct. 4, and we’re going through the X’s and O’s of the IPO process. I’m your host, Dylan Lewis. I’ve got Motley Fool Premium analyst Joey Solitro with me in the studio. Joey, you are quickly becoming a regular here on the show.

Joey Solitro: Hey! I wouldn’t have it any other way!

Lewis: It’s great having you on! Today we’re going to be talking about an email that we got from a listener. Andrea wrote in and wrote to us and said, “My broker recently offered pre-IPO shares of Peloton two days before it went public. It’s the first time this has happened. I wasn’t aware it was even possible for a lowly individual like me to get in on an IPO.” She goes on to explain that she did some homework, and decided Peloton was a no for her, but wound up having a lot of questions after this whole process. She writes in, “This made me wonder a bit about how IPOs work. Maybe there will be a next time with my broker. As it’s never been an option for me before, I’ve never looked into it, so I don’t understand the whole process. For example, why so many changes last minute? How is it that WeWork got one pulled last minute? Why do they never know what the IPO will be priced at until the last minute? Etc., etc.? It seems surprising to me that there aren’t stricter rules around this.”

It led you and I to think, “Wow, we probably haven’t ever done anything that breaks down how the IPO process works and why there is so much vagary around the process up until shares actually price and hit the market.”

Solitro: Yeah, there’s a big gap between when companies say, “Hey, we’re thinking about going public in the next 18 months,” and then you hear, “So-and-so has filed confidentially.” And then you finally see the paperwork. It’s a very long process. Some investors get lost along the way. But it is very complex, so it does deserve the time that it takes.

Lewis: So, this is going to be a timeline of what that process looks like. Hat tip to Andrea for making this episode happen.

Solitro: Thank you, Andrea!

Lewis: Listeners, if you have stuff you want us to talk about, we love getting ideas for shows. Please write in.

What ultimately kicks things off with the IPO process is the company saying, “OK, we’re going to go public.” Usually, this is an internal discussion. Maybe they’re getting some pressure from investors, saying, “Hey, guys, are we going to have this liquidity event?” Typically, management will make this decision, and you’ll start to see some staffing changes if it’s a younger company that has a slightly less experienced management team.

Solitro: Yeah. In today’s day and age, if you’re a tech company, or any company in general, when you raise cash, you are going to go public eventually. It’s just in the cards. It used to be, the first three to four years, then it became more like seven years was the standard. Now, you’re seeing even 10 to 13 years. But as soon as you take that venture capital money, the clock’s ticking. Companies know, “OK, we’re going to be going public eventually.” After the seed round, they’ll have round A, B, C, D, E of their funding. But then you’ll start to see the staffing changes, like you mentioned. Usually they’ll hire a CFO that’s been in the position to take a company public before. You’ll see them hiring a lot of people in the finance department because they need to get those financials in order to be able to pass the test of a big investment bank.

Lewis: A lot of people will look at the job postings for some of these hot start-ups and say, “Oh, they’ve got a lot of accounting positions. They’ve got a lot of finance positions open. Is it possible that they’re going to be weighing an IPO down the road?”

Solitro: I do that quite often. I’m one that buys a lot IPOs. I’m always in touch with all the different unicorns as they’re coming public. I’m even an accredited investor, to where I’ll be looking at a lot of these companies trading on secondary markets, where insiders are looking to dispose of some shares to get liquidity themselves. I’ll always look — are they hiring a new chief financial officer? Have they recently hired one? What was his background? Oh, he took this company public. Or, oh, she was over here. And then, of course, yeah, that led to an IPO. So, yeah, that’s one that I’ll definitely look at, mainly in the finance. If they have a lot of engineer openings, that’s very common, because they’re spending to grow right there. But yeah, always look for those finance and accounting positions because they’re getting those numbers in order for a reason.

Lewis: And then basically, you will see the paperwork start to happen, right? You hire the people that can make that paperwork happen, then you start putting the paperwork together. The form that we tend to pay the most attention to is the registration statement, or the S-1; very often, you’ll hear us call that the prospectus.

Solitro: Yes. That’s the initial one. That’s the big document. It takes them quite a while to get that in. It’s almost the most intense background check you could ever run on a company. They not only want to know every dollar that’s been accounted for in recent years, but they want to know all related party transactions, they want to know everything you’ve done, and who you’ve done it with, to lay it all out on the line.

Lewis: It used to be that this was a document that, when filed, was pretty quickly available to investors. That has changed a little bit. You’ll see a lot of news reports around this. A lot of the financial media will follow this and say, “Oh, we’re seeing these hirings. It looks like it’ll happen at some point in the next year or so.” Often, the company will even indicate, like, “By 2020, we want to be public.” And then you’ll see that news break that says that WeWork or Peloton or Lyft or whoever confidentially files an IPO registration statement. And you’re like, “Well, wait a minute. How come it’s confidential?” That’s because of a lot of the changes that came in with the JOBS Act, recent legislation around emerging growth companies, and now just all companies. If you see that confidential filing, there’s nothing shady about that. It’s just the new process for IPOs.

Solitro: Yep. That’s where you can almost make a note of it, put it on your watch list. I always take a sticky note and slap it on my computer among the other hundred that’s there, and just know, keep checking different websites, see if that’s finally available. But yeah, filing confidentially is the name of the game these days. Don’t think that’s too shady. Just know, it’ll become available in the near future.

Lewis: The reason that exists, that confidential filing, it’s supposed to be a pro-business move. If you have to make your books public, there are competitive disadvantages to doing that, especially if you’re in a highly competitive industry. If going through the IPO process puts you at a disadvantage relative to companies that are currently private, it may disincentivize companies from doing that. So, they made this confidential carve out so that more companies would be incentivized to go public.

Solitro: Yeah, because you’re actually listing major customers of yours, who represents what percent of revenue. If one customer represents over 5% of revenue, it’s in there. So, then your direct competitor could be like, “Hey, we’ll beat them on price. Let’s call so-and-so at this company that we know.” Or, you usually put in who your technology partners are. If you’re a smaller start-up that like, “Wait, how does Lyft do this, exactly? Oh, wait, they’re partnered with this company.” Yeah, it’s only a couple of weeks, and they can’t do a lot of damage up to that point, but you are almost telling all your secrets without telling your secrets.

Lewis: We probably need to rope in the bankers at some point during this discussion, and explain the underwriting process a little bit. You have the paperwork that is put together. Very often, you have underwriters that are helping put that paperwork together.

Solitro: Yeah. That’s pretty much what they do. These big financial institutions, it’s all they do. They’re going through your filings, making sure everything’s there. If there’s corrections that need to be made, or something that was forgotten — if they’re going to put their name on it, it’s going to be perfect, and they’re going to charge you a lot of money for it.

Lewis: The way I liken it is, you have a real estate agent when you buy a house. You are not buying a home very often, if you’re the average person. Companies do not go public very often. Even if you’re a seasoned executive that has taken companies public several times, maybe you’ve done it three times. So, you’re going to bring in an underwriter — a Goldman Sachs, a Morgan Stanley, someone who specializes in this — to make sure that you’re doing it correctly, the same way that you would bring in a real estate agent if you’re buying a home.

Solitro: Yeah. It’s pretty much like you’re paying for the relationships that they have. You not only want them to go through all of your filing to make sure that it’s perfect; but then, they usually have relationships with the NYSE or the Nasdaq, and they have relationships with all these other investment banks that they need to partner with to actually sell your shares to, to have them sell to their clients. So, yeah, it’s almost like, you know what you want to do, but you need that middleman to help you do it.

Lewis: So, as that’s going on, very often, you’ll have the bankers begin reaching out to some of their industry contacts and saying, “Hey, we’re going to be handling this deal. We want to gauge your interest.” In the lead-up to the company actually going public, that’ll more formally take root as the road show, where the management team and underwriters go out and meet with all of these banks, big institutions, people who have a lot of money to throw around, and give them the pitch on what the company is.

Solitro: Yeah. Not every company is someone that everybody knows. With Zoom and Slack, most people in the industry knew them. Almost everybody’s using Slack, it seems, these days. Not everybody has the reputation to just come public. A lot of those companies, when they don’t need money, that’s when they can do a direct listing. But most of the time, they’re smaller companies. They might not be in a cash crunch and need it, but since they want to go public — not everybody knew what Datadog was. They needed to have that investment banker go around and say, “Hey, here’s everything that’s on there.” So, yeah, they’ll put together that roadshow presentation. You’ll see the growth that the company’s got. And then, usually, after that roadshow, those people go back to their clients. And that’s where you start gauging demand.

Lewis: Yeah. It’s an important part of the process because they’re taking feedback from every one of those presentations and getting a better sense of what the market appetite might be for shares.

Solitro: Exactly. OK, everybody loves tech companies, everybody loves subscription revenue. Datadog coming, I’m sure the demand there was very high. But in other situations — if it’s, like, a small biotech that’s trying to cure cancer, where there’s hundreds of those, and they don’t always work out, there might be far less demand for that. Those might be specific funds, or specific people that want to have their hat in the ring with those.

Lewis: If you’re listening through this, you might be saying, “Well, wait a minute. All of these high net worth individuals, all of these big institutions, they’re getting access or information that I’m not. When do I get my hands on the filing? When do I get to see the core business results?” If the company ultimately does wind up going through with the IPO, just over two weeks before that happens, the S-1 is no longer confidential, it winds up becoming public. At that point, that’s when you and I wind up getting our hands on this thing and digging into it for, like, an Industry Focus episode.

Solitro: Exactly. That’s where a lot of things take a turn for the worse. There might have been incredible demand for WeWork, for example, until that S-1 came available, and everyone starts looking through it, combs through it and sees, “I don’t like this, I don’t like this.” Then they start realizing, this is a real estate company trying to trade at a tech company valuation, and people see through the smoke. And you saw retail investors absolutely turn on them. That forced the investment banks and everybody else to take a second look, like, “OK, maybe we don’t want to be participating in this.” That’s when you see the valuation start coming down and down and down. As soon as that S-1 is released, that’s where the real demand can be seen. Then you’ll get the financial media all over it. That’s where things can really unravel for a company.

Lewis: Yeah. I wish that we could get our hands on this earlier. I understand the process, with the confidential filing and why it exists. There are some good reasons for it. I do wish that we had a little bit more than a couple of weeks of lead time. But the way the news cycle works, very often, we’re able to get out the important stuff in that amount of time. But, these prospectuses are 200 pages, 300 pages. It’s a lot to work through in a short amount of time and really do your due diligence, especially if you’re looking at things like related-party transactions, or some of the moves that may make you scratch your head and wonder exactly how the incentives are aligned for a business.

Solitro: Yeah. Like you said, some of these are 250 pages long. I’ve gotten to the point where I know the sections that I want to see. As I’ve said before, I always have a generalization of what a company does, but then I’ll always look at the numbers and then go back to it. It’s almost like backing into what the company actually does. I like to let the numbers speak for themselves. But then, yes, like you said, you want to go through those related-party transactions. OK, the CEO’s brother and sister own a cleaning company that cleans this entire building that they’re headquartered in, and, wow, they make $250,000 on this contract. But then you have to look — what’s the average cost to do that? And it might be legitimate. It might be three times the normal amount. So, yeah, there’s a lot of combing through. I would love to have my hands on it as soon as the investment banks do. But what can you do?

Lewis: Yeah, sometimes you just have to wait. The thing that you will tend to see during the lead-up, the couple of weeks ahead of the IPO, is a price range emerge. This is getting at one of Andrea’s questions. How is there a range on this thing? One of the important things to remember with the IPO process is, you’re taking something that is fairly illiquid — you’re taking a valuation that maybe is updated once a year or twice a year, if they’re going through a ton of capital-raising events — and then you are trying to set it to something that the market will respond to, and liquidity will be like that, it’ll be available all the time, and the price will basically reflect the current attitude in the market. It’s a very difficult thing to do.

Solitro: Yeah. With the whole price range, you have to understand that as these companies raise money over time, they’re going to have different share counts, and it’s going to be a different share price on those. There might be a $2 billion start-up that, its last raise was $4 per share. Or, you’ve got Airbnb that’s pushing $30 billion, and their share price is over $100. We know share price doesn’t really mean anything, but what that share price range is usually based on is the last time they raised capital, and if they believe that they should be trading at a premium from that. If the last capital raise was of $1.2 billion, and it was $6 a share, hey, we might want to go public at $2.4 billion and $12 per share. But that’s where you’ll get the range, so, $10 to $12. But then, as they proceed on that road show, they see the demand — like, wow, this is going to be well oversubscribed, we’re going to bump up that range, maybe $14 to $16. And if the demand is still there, they might even raise it again. But that’s where the whole price discovery comes into play.

Lewis: Yeah. You said oversubscribed. That means demand is higher than supply. You’ll also hear undersubscribed. If you’re about to go public, that’s not a word you want to hear. Basically, it means that demand for shares is lower than the supply that you are looking to sell. Those are the types of things that will push shares to price above a range, below a range, in the middle of a range. If it’s exactly what they expected, well, you’re probably going to end up dead in the middle of the range. But it can be a little weird to look at it and say, “Well, they’re saying $17 to $21, but they priced it $25.” How does that happen?

Solitro: Yeah, that’s the thing. If demand’s where you’re setting your range, or below, like you said — if there’s 10 million shares available, and only five million, so you’re undersubscribed, there’s a very good chance that will be postponed or completely withdrawn. Or, if you’ve got demand for 20 million shares and you’re only bringing 10, that’s where you’ll see that price range go up. So, it’s almost like you want to water down the demand. It’s almost like they don’t want to leave too much money on the table, but they still want that first-day pop because it looks good in the market.

Lewis: This gets into the incentives of the IPO process, which we’ve talked about a little bit. You have a company that is trying to raise money. They’re giving away equity, trying to raise money. It’s a capital-raising event for them. It’s also a liquidity event for its shareholders. You have an investment bank that is facilitating that process, collecting fees on that process. Very often, they have a commitment to own a certain number of the shares as part of the offering. And they are facilitating the entire offering by connecting the company with their high net worth individuals, or these institutional clients that have huge budgets and have an appetite for these. The underwriting banks don’t want to sell a dog to their high net worth individuals. They want to be giving them a good investment opportunity. Their pricing might be a little conservative so that there’s some upside. The company is saying, “Well, we’re raising capital and giving away equity. We want to make sure we’re maxing out this valuation.” Those can sometimes be at odds with each other.

Solitro: Yeah. This is where it comes into play, where the big investment bank is thinking for themselves and their clients, as well as this company they’re bringing public. They want to get them liquidity, but they might not give them every dollar that they’re worth because there still has to be room for that demand to be there. If they start contacting their high net worth clients, saying, “Hey, we’re going to bring this public. We think there’s going to be significant one-day pop, a pop on the first day,” it’s almost like that’s their incentive for helping bring that company public.

I always like to say, if a company comes public and I like it and it goes down, they just didn’t leave any money on the table. But in a market psychology sense, they want that first day pop because then you turn those traders into long-term holders. A Beyond Meat comes public and just rages out of the gate. They did leave quite a bit of money on the table. They could have priced it higher. But maybe the demand didn’t say it was there. They priced at a range that they thought was reasonable for them to raise the money, and the people that got that allocation, wow, they must be happy.

Lewis: Yeah. To be clear, some management teams want to see that first-day pop, too. They love the publicity of saying, “Oh, shares are up 25%, 30%,” whatever it might be. Conversely, if you price it to perfection, and it’s a 0% move, it’s pretty ho hum. Or, some management teams will wind up with a “broken IPO.” The financial media loves saying “broken IPO.” That means that shares are below where they priced. Yeah, that meant that they price their equity and maxed out the value, but there’s a lot of negative press that comes with that. You have all these people are weighing all these different things.

Solitro: Yeah. It’s very good to get coverage from the big media outlets where, “Oh, this first-day pop of 58%!” Say you price your IPO at $20. It doubles on day one to $40. Then, when it pulls back to $39 and change, or drops to even, say, $31, people might think, “Oh, wow, that’s a steal. It’s down x%.”

Lewis: And it’s still above whatever they priced at originally. There’s still that positive momentum there. It’s all to say, the night before the IPO, you’ll generally see the offer price be solidified. If you are on the receiving end of some of this information from your bank, maybe they’re trying to prove their value to you and offer you some access to some of these IPOs. You’ll see a range often, and then maybe a more solidified price if you decide to commit to buying some shares. But very often, if you are making that commitment, you’re doing it at a range rather than a specific price.

Solitro: Yeah. So, you’ll pretty much get a solidified range, and they still might price $1 above that range. But this is where Andrea was talking about, where her broker gave her access to it. How that works is, these underwriters will have relationships with brokerages or with these other banks. I know for a while TD Ameritrade and Charles Schwab had deals with Goldman Sachs, to where anything they were underwriting, they would get a specific amount of shares. I read that Fidelity has a deal with Credit Suisse. Depending on who your broker is partnered with on the investment banking side, you might get that notification. “Hey, if you want to participate in Peloton’s IPO, here’s the projected range,” you could say how many shares that you would like to purchase, and at what range. You have to have that cash sitting in your account to do it. They won’t let you do that on margin. That’s when, it’s almost like account value comes into play. Even though they’ll tell you differently, I got one of my brokers on the phone, and I was like, “Look, I need you to be honest with me. How does this work?” If you say, “I want 1,000 shares,” but your whole broker is given a million shares to give among their clients, and you want 1,000, but your account might only be $150,000, they’re going to give it to their clients with several million dollars. They say that they go in 100-share spurts, like they’ll just keep going around so everybody gets a bite of the pie. But I don’t believe that for a minute. I feel like they’re giving big allocations to their most important clients and it’s whittling down. But, you indicating that interest is how they gauge demand. So, then they could price it and say, “Yeah, we’ve got these amount of people.” And once you’re locked in, there’s no going back. Once it comes that next morning, if you indicated interest in that thing, it might come to you.

Lewis: Yeah. Speaking of incentives, for these brokerages, it’s a chance to give the people that have very large account balances with them that white glove treatment, and say, “Hey, we’re going to give you access to this thing that only institutionals have access to, or only super high net worth individuals have access to via investment banks. We’re going to get you in there.” So, for them, it’s a little bit of a marketing, client services thing.

Solitro: Yeah. That’s more important than ever. The race to zero has officially come true. You’ve got TD Ameritrade, Schwab, E*Trade, everybody’s $0 commissions. They’ve got to find more reasons to retain clients. If they can say, “Hey, we have access to this amount of IPOs this year, and we expect more next year,” it’s all about how to retain those clients. If having IPO access is one of those kickers, more power to them.

Lewis: If you do wind up participating in this, you will have the underwriter hook up your brokerage, and then the brokerage will deliver you those shares. You’ll have where the shares price for that first offering. You have to remember, that’s the primary sale. That’s the capital-raising sale. Then, the morning of the IPO, you have a second phase of price discovery, Joey.

Solitro: [laughs] Yeah. This is where the rich get even richer. You have that initial pricing. You might have a small allocation at those shares. But then they’re still contacting different clients. They’re all talking. That’s when you get the CNBC coverage of the booth, and it shows everybody yelling at each other, like old school, “buy, buy, buy! sell, sell, sell!” type of deal. They’re finding that sweet spot for those shares to open. That’s when the really rich clients are sitting there, like, “OK, I got mine at $25. Early indications are $42.” That’s when they’re licking their lips, waiting for that to open.

The second price discovery is almost like, we found where the market demanded this, or where everything laid out, to where we think this is a good price to come public at. But now, let’s find out what we want it to open at.

Lewis: That’s why, when the market opens, and it’s day one of trading for an IPO, the shares will not immediately be available. They are going through this price discovery process to say, “OK, let’s gauge interest on the buy and sell side, see what we can do here to get something that feels reasonable, maybe give some upside for these first couple of trades, and establish a market.” Yes, the incentives at play are questionable sometimes. But also, it comes back to this, we are trying to put this in a position where it can participate in a highly liquid market where prices can move by the second, when the valuation for this company has been fairly static in six-month or 12-month chunks for its lifetime so far.

Solitro: Yeah. You always have to remember, there are those circuit breakers in the market. If a company soars out of nowhere or plummets out of nowhere, it’s going to hit a circuit breaker. Trading is going to be halted. If you had a company come public, and they open for trade at 09:30 AM, and all of a sudden, there’s 10 million shares trading hands and the stock jumps 40%, you’d have trading halt after trading halt after trading halt. That early price discovery is more like, if it opens up $42, then, yeah, it might trickle down to $38, or up to $52. It’s not going to be as significant as a move as that opening trade. But it’s almost to keep everything in line and make sure they don’t break anything.

Lewis: At this point, we are on the secondary market. All trades are not capital-raising events for the company itself. They exist between investors. If you buy shares in the first offering and sell them to me, you’re the one that’s pocketing that money. None of that money is going to the company. We are effectively on the Nasdaq or the New York Stock Exchange, and just transacting that way.

Sciple: Yeah. If you end up participating in the IPO, if you’re an insider that’s still holding shares, you’re going to have that lockup period where you can’t be selling. Or, I think how TD Ameritrade had it for me, if I was to participate in an IPO, I had to hold them for at least 30 days. They try to prevent you from doing it, but there’s nothing to stop you once they’re in your brokerage account. You could immediately sell it, and then they might make you not participate in a couple. I tried to participate in a bunch through TD Ameritrade. I never got allocated anything. I think our viewer that sent in the question, Andrea, you had an opportunity — even if you indicated interest, there’s a very small chance you would have gotten it unless you have a massive account. Then, hey, good for you. But, yeah, they do have that lock-up period to try to prevent too much selling.

That’s where the secondary reasons come into play. If you’re Beyond Meat and you go public at one price, and out of nowhere, you’re over $240 a share, and you want to raise capital again, that’s where you can raise some significant capital.

Lewis: I think we’ve touched on most of the questions from Andrea’s email. There’s one more outstanding that I want us to hit. You got there a second ago. Should investors participate in that first round, if they’re offered? What are the risks? I go back to what you were saying before about allocation. I think it really comes down to how big of an account you have, and how willing you are to put a decent amount of your assets behind something that is just going public.

Solitro: I’m almost always fully vested. It’s more likely that I’ll have some cash on my margin than there will be cash sitting on the sideline. I just think having money sitting there is a complete waste. So, for me, if I was going to participate one of these IPOs, I would have to sell something that I already own to indicate interest to my broker to then try to get some allocation. For others, if you have a lot of cash sitting on the sideline, and you really like the company, you’ve seen the financials, you really believe in it, that’s where you might say, “OK, I’m willing to put 2% of my capital into this, or 1% of my capital.” But then you have to factor in, if they’re actually giving out these 100-share allocations at a time, you might indicate interest for $10,000 worth of shares and you’re given $1,000. You have to be ready to purchase the bulk of your position after the company opens for trade. And then it’s almost like, do I really want to have this tiny position sitting there like? Or, do I want to just watch the open, see what happens, and maybe buy at the opening trade? Or, kind of like I have with Datadog and other ones, watch it, see what happens, and buy it later on?

Lewis: My concern with this is people being pressured into a position where they’re putting a little bit more behind something than they maybe want to, because they want to make sure that they get some of that allotment. If you don’t have a very large portfolio — say you have a $50,000, a $20,000 portfolio; anything lower than that, certainly, too — you’re going to have to put up or commit to probably several thousand dollars in order to have that order filled. That’s going to be a big chunk of what drives your returns. If you think about diversification, making sure that you’re not too weighted to any one position, that could put you in a tough spot, especially if, like we’ve seen with a lot of these IPOs, they wind up trading well below offering price a couple of months out.

Solitro: Yeah. That’s where a lot of brokers have gotten better. They’ll have account minimums to be able to participate in their IPOs. But not all do. But yeah, like you said, if you have a $50,000 account, and you decide, “I love this company,” you don’t want to put your whole account into that one company. Especially lately. It used to be, no IPO could do wrong. It was almost like everything that came public was popping 40%, 50% on day one and just keeps running. Now, it’s almost like retail investors are getting smarter, combing through these releases. You saw from WeWork. That got pulled after. You saw changes in management, the valuation changed five different times before it got pulled. And then, even this week, there are supposed to be five biotech companies going public this week. Two got postponed or withdrawn. One priced below the range, one at the midpoint. You see the demand for IPOs isn’t there like it was earlier this year or late last year. But it’s almost like, yeah, these retail investors are starting to get smarter, combing through these releases, seeing what these companies really do.

Lewis: The way that I like to think about IPOs as an investor is, they’re similar to being at a wedding, as someone watching the wedding, like a friend or a family member, especially if you’re single. You’re at this wedding. It’s this big event, it’s this huge proclamation of love. Emotions are soaring. There’s this euphoria. While it seems really seductive in that moment, you have to remember, you have years of marriage after that. It’s the same thing with the IPO process. You have all this fanfare, all this attention, all this hype around this company. They still need to be a good company day two, day 10, day 10,000. You can get in later as an investor. You don’t need to feel pressure to propose immediately to your significant other just because you’re at a wedding. Similarly, you don’t need to buy shares just because it’s going public. You can buy shares day two, when it’s hit the secondary markets.

Solitro: Yeah. It still comes to play that these are coming public in the stock market. One bad headline out of the White House or anything like that, and the whole market starts pulling back. So, yeah, you see a lot of these great IPOs, or these great companies coming public, and it might rage out of the gate, but it pulls back with the rest of the market. Like you said, don’t let the wedding day or the honeymoon be like, “OK, I didn’t get in on day one. I have to get in on day two, or day three.” Sometimes it’s best to wait for that first earnings release. That’s where a lot of pressure is going to be on that company. If you miss the mark on the first earnings report, you could be taking a 20%, 30% haircut.

Lewis: Yeah. It can be rough, especially if it doesn’t line up with guidance. I think that’s why we generally tell people, buy your positions in chunks. It’s OK to get a tracking position in a stock that you’re interested in, especially if it’s small, early on. But remind yourself that you’re buying maybe three or four times to build out the full position, rather than anchoring your cost basis to just one point in time.

Solitro: Exactly. IPOs are the ultimate “scale into your positions” play. There’s other situations where you might want your full allocation right there. I’m definitely one that, if I love a company enough to buy it right at the open — I don’t always put a market order. I’ll always have a limit order, right around where the indication’s going to be. But, yeah, I’ll never purchase the full position because I know, if it’s going to pop 40% of the gate, it could end the day up 20%, it’s still a great day, but wow, I just took a major hit. Always buying in those spurts. Buy some here, maybe wait until after the first earnings report. Don’t let the whole FOMO thing get you. I think that’s what got the IPO market as juiced up as it is, that fear of missing out. People need to just — on IPO day, throw on that Taylor Swift song “You Need to Calm Down.” Just relax, take a deep breath. I had to bring that one up because it’s been stuck in my head all morning ever since listening to it on the ride in.

Lewis: [laughs] If we had the music rights for it, we should totally play that at the credits. Sadly, I think Taylor Swift’s PR team might hear it and know that we don’t.

Solitro: Same with for this podcast, that whole Friday, the most annoying song ever? If that was the intro song…

Lewis: You know what’s funny? I haven’t heard or thought about that song in about five years, and I’m going to have to listen to it after the show. Thank you for the great advice, and I hate you for putting that song in my head, Joey.

Solitro: Austin, can you do that for us?

Lewis: [laughs] Joey, thanks so much for hopping on today’s show!

Solitro: Always a pleasure being here!

Lewis: All right, listeners, that’s going to do it for this episode of Industry Focus! If you have any questions or you want to reach out and say hey, shoot us an email over at industryfocus@fool.com. We’ll probably use it for an episode. We love getting emails. I can’t emphasize that enough.

Solitro: Ask a lot about IPOs and tech so I can come back.

Lewis: Joey plug, right there. If you don’t want to email us, you can tweet us at @MFIndustryFocus as well. If you want more stuff, subscribe on iTunes, or you can catch videos from the podcast and tons of other content over on our YouTube channel as well.

As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don’t buy or sell anything based solely on what you hear. Thanks again to Austin Morgan for all his work behind the glass today! Go Nats! For Joey Solitro, I’m Dylan Lewis. Thanks for listening and Fool on!

The post The X’s and O’s of IPOs appeared first on The Motley Fool Canada.

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Tune in to learn what each business does; why SmileDirectClub is tech-y enough to warrant some time on this show; how the financials look for these three; how investors can tell all these similar-sounding software-as-a-service companies apart and really figure out who’s best in class; what risks to keep an eye on, especially with Cloudflare; some general rules of thumb for long-term IPO investing; and more.

To catch full episodes of all The Motley Fool’s free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on Sept. 20, 2019.

Dylan Lewis: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It’s Friday, September 20th and we’re talking about some fairly new publicly traded companies. I’m your host Dylan Lewis, I’ve got premium analyst Joey Solitro with me in the studio. Joey, what’s been going on, man? You’ve been all over the place the last couple weeks. Podcasts, YouTube lives. I don’t know how you’re doing it.

Joey Solitro: My companies are all the rage these days so I’m getting some extra attention. I’m loving it. As long as IPOs and SaaS stay in focus, I’ll be here.

Lewis: We’re happy to have you here. We’re going to be talking about some tech companies, some ones that you follow. If folks are interested in the SaaS space, you did that YouTube Live a couple weeks back with Chris and Jason Moser. That exists over on the YouTube channel, in case people want to check that out.

Solitro: Check it out.

Lewis: Check it out. We’re talking about three companies today that have gone public in the past month, which is kind of wild. People tend to really pay attention to the IPO calendar when the big names go public — the Lyfts, Ubers, Pinterests of the world. The reality is, companies are going public all the time.

Solitro: Yeah, I wish people would stop paying so much attention so I could get a decent valuation here and there. But I’ll take them when I can get them.

Lewis: [laughs] We’re going to cover these in chronological order. We’ve got Smile Direct, Cloudflare, and Datadog. Definitely three companies that we’re going to have to explain a little bit. They don’t have the brand name recognition of some of the other IPOs we’ve talked about in the past. Let’s talk about Smile Direct Club first.

Solitro: I’m sure a lot of people know the Invisalign brand for braces. What these guys have done is, Invisalign is actually a supplier of theirs, where they’re going direct to consumer with these. They’ll have their mold kits, or you can go into one of their Smile shops. They actually have partnerships with CVS and Walgreens, so they’re going to start popping up in there. And basically, they take a scan, or they take this mold of your teeth, they ship it to their orthodontists over in Costa Rica, and they create this plan. And then it comes back to a local orthodontist near you that says, “Yeah, they’re a candidate for this. Let’s give them the green light to go.” And then within three to four weeks, you have your new, clear aligners.

The cool thing about them is, they’re reducing the cost of doing this. I was doing some research, and traditional braces, whether metal or through Invisalign, is $5,000 to $8,000. Smile Direct is $1,895. They broke it down below $2,000, and you’re going to be wearing these for five to 10 months instead of 12 to 24 months. Shorter time, less money, you don’t have to waste your time going to the orthodontist 10 to 15 times. It’s just a great business model. The growth is real with this one.

Lewis: The way that I think about this one is Warby Parker, but for teledentistry.

Solitro: Exactly.

Lewis: They made their money, and they really got into a market, by saying, “We can cut out a lot of the costs that come with eyewear. We don’t need all these flashy retail locations.” They ultimately decided to do that. But for a while, they were saying, “We’re going to cut all that stuff out, we’re going to bring the cost down, because we’re doing a direct to consumer model and we don’t have nearly as much overhead as some of the other guys out there.” That’s what Smile Direct has done. The difference is, they’re doing it with dentistry.

Solitro: Pretty much, yeah. If you own your supply chain, you can completely reduce the cost. You could go to an orthodontist who buys materials from this person, or has this person make their braces or their aligners. Or, you can go to this one company that cut out a lot of the fat, reduced the costs, and it’s going to come directly to you.

Lewis: You mentioned the growth. There are some pretty staggering numbers if you look at the financials. They were up 184% year over year in 2018, over 100% year over year growth in revenue the past two quarters. It seems like this concept is catching on. When you come into the marketplace at a lower price, people tend to pay attention.

Solitro: The other thing, on top of the very impressive growth, gross margin over 75%. I was not expecting that. I thought, based on this growth and what they’re doing, they’re probably under 50%. I was shocked. And then you see they’re aiming for I think was 80% to 85% gross margins long-term. That’s not that much of a stretch.

Lewis: Some other stuff that I really like with this business — people might be surprised that we’re talking about it on a tech show, because this is, in some ways, a consumer goods company. But ultimately, the reason that they’re able to offer these lower prices is, they’ve figured out a more integrated system to make all this happen. I’m going to give them a tech check because of that. You look at what they have in terms of inventory, it’s tiny. They have very little inventory given what they do in sales. $13 million in inventory at the end of a period where the company did almost $600 million in trailing 12-month sales. You don’t see that too often for anything in the consumer goods space.

Solitro: No. That’s one thing I don’t play with — I don’t like companies with inventory. I love my SaaS companies. If you have a product housed and you have to sell it, and it becomes this toxic inventory, it’s just something I’ve never had success investing in. Traditional consumer goods with these heavy inventories, retailers. So, yes, to see this, that’s definitely what I would consider tech because teledentistry, it’s almost like Teladoc, where they’re saying, “Instead of going to the doctor’s office, we’ll bring the doctor’s office to you.” They say, “Instead of going to the orthodontist, we’ll bring it to you and make it much easier and much cheaper.”

Lewis: And if there’s anything we’ve learned over the last couple years, it’s that people will happily take things delivered to their doorstep, pretty much regardless of the industry.

Solitro: I think I’m a very active person, but if you tell me, “Hey, you don’t have to go to the grocery store, you can go through Instacart,” or, “You don’t have to go to the doctor, use Teladoc,” it’s one less person for me to have to see and pay an inflated amount of money. I’ll pinch pennies here and there. Plus, I have two daughters and a son on the way. You’re telling me I could spend $1,900 for braces instead of $5,000 to $8,000 apiece. I know my wife was telling me she had to wear braces for over two years to have some correction. I can only imagine how much that was costing her parents. This is just a win-win on both sides for me.

Lewis: Good for consumers. And it seems like it’s going to be good for them as a business as well. There’s one thing I think that’s worth highlighting here. They are not profitable, as you might expect for a company that has recently gone public. The spend is coming on acquisition. That’s really what’s taking them into the negatives. A lot in SG&A and marketing. We talk about software businesses a lot. Some of the companies we’re going to be talking about check this box as well. You spend a ton early on to scale your company. And then you have the lifetime value of the customers that you bring. Takeover. That exceeds whatever you spent to bring those customers in. I buy that narrative for a software business. I worry a little bit with a more consumer packaged product. If someone buys something, or they have this orthodontics kit delivered to them, they aren’t a lifetime customer, necessarily. They’re being serviced themselves. Once they have their teeth all in order, that might be it.

Solitro: Well, then you have the retainers. They also do the retainer business. You do have that. One thing I like to say is, they’re in the ultimate land grab right now. They have a couple competitors. I know Candid is a notable one. I was looking through their S-1. I think they had three other competitors that are like them. So you have to remember, Invisalign, their patent came off in late 2017. 2018 was pretty much where these guys had to start pumping out as much marketing as they could to acquire as many customers as they could. I think they’ve been in operation since 2014. It’s pretty much been in preparation for this ultimate land grab that’s going on right now. It’s almost like you have to be in the market for it. If you search invisible braces or Invisalign, of course these companies are going to pop up, because that is becoming more popular. Especially for older people that didn’t have braces in middle school or high school, they don’t want to be walking around with mouths full of metal right now. That’s definitely what I would be doing, I’d go the invisible route, especially if you’re saving money and it’s less time. So I think people are going to be looking for those alternatives. And it’s that land grab. That’s the only term I could really use.

Lewis: The counter to that point is, if you have a family of three, you spend to get the first kid, from a marketing perspective. And if a family has three and all three need braces, well, there you go, you’re fine. You can get the word of mouth going, and then the business results will just take over.

We’re going to switch gears and talk more traditionally tech here. Our second company that has gone public in the last month is Cloudflare. This one’s going to need a little bit more explanation, Joey. [laughs]

Solitro: Even for me. [laughs] They’re basically a cloud platform. They make sure all of your mission critical applications are operating as they should to prevent downtime for your website. In the increasingly digital world, outages can be the death of your company. We talked about the same thing with PagerDuty, where they would alert the exact person that you would need to fix a specific problem. These guys help you monitor everything and also they prevent cyber-attacks. I was looking through their S-1. They say they block 44 billion cyber threats from 20 million internet properties daily.

Lewis: Which is baffling.

Solitro: Yes. I thought that’d be an annual rate. 44 billion cyber threats are blocked from 20 million properties daily. And then, they have customers that include SaaS superstars, Adobe, HubSpot. Then you’ve even got big retail names like Shopify and Walmart. But then you’ve even got, they’re doing this for the FBI, the U.S. Department of State. If organizations like that trust Cloudflare to do what they do, they must have a great product. They have 74,000 customers right now. They’ve added 7,000 this year. They’ve still got a lot of companies that can be added to this mix.

Lewis: Working with the government is generally a pretty good stamp of approval, huh?

Solitro: Especially the FBI and U.S. Department of State. That’s no joke.

Lewis: For this company, all of that has materialized into a pretty good growth story, as you might imagine. The tailwinds here are very strong. I don’t think those cyber-attacks are going anywhere. If anything, I think they’re probably going to become more prevalent as we move forward. This was a company that actually enjoyed reaccelerated revenue growth. For the first half of 2019, revenue hit 48% year on year versus a 2018 growth rate of 43%. You love to see that acceleration.

Solitro: I love to see accelerating revenue growth. It definitely shows that either the business has been getting more attention from the companies that it should, or their marketing spend was going as they wanted. I always go back to our favorite statistic, the net dollar retention rate. That’s been over 110% for the last eight quarters. Their existing customers are consistently spending more. And, they are adding a good amount of customers. That’s when you get that beautiful cohort analysis, where they’re adding more clients, existing ones are spending more. This accelerated revenue growth, while it might decelerate starting next year, it’s still well over 40%. I think the compound annual growth rate since 2016 was over 50%. That’s very impressive.

Lewis: When you can grow your business without having to add any new customers, that’s awesome. And then, other new customers that are coming in are gravy. That shows you are building a product that people want, people are increasing their spend with you, and they’re very happy as customers.

We teased this, but this company is losing money. It’s because of sales and marketing. They are investing heavily, much like Smile Direct. That’s kind of going to be the theme of today’s show, is investing heavily because the opportunity is there for all these businesses.

Solitro: Exactly. There are some red flags that come with Cloudflare that I don’t traditionally see with the SaaS companies that I follow. This is one of the reasons I did not purchase Cloudflare. I actually own Smile Direct, for full disclosure. But when it comes to Cloudflare, they’ve had two mass outages in the last year. For a company that is supposed to keep my company up and running and prevent outages, to have two outages in the last year? That’s pretty bad. And then, they stated in the last week that they may have violated U.S. sanctions by providing services to terrorist organizations and drug traffickers. Their defense over this is, “Hey, we couldn’t say this going to the IPO because we were in a quiet period.” I think, well, how convenient for them.

And for them to not have known that ahead of the filing … I feel like you should know your customer base better, or do your due diligence on them, and say, “We’re going into the biggest liquidity event in our history. Maybe we should make sure we’re not servicing some terrorist organizations.”

Lewis: Yeah. The generous interpretation of that, just to dive into the idea of a quiet period for a second, is, when you have this filing out there, management cannot go out and make certain comments about the company. It’s something that is part of the IPO process. If they were to have discovered it, truly, during this period, management would have been in a position where they probably couldn’t have talked about it. But, I mean, yeah … this seems like a pretty big deal.

Solitro: It’s the ultimate “come on, man.” I was on the fence about buying this one. As we’ve talked about previously, I buy a lot of IPOs on day one. I have a completely different investment strategy than most people and even most Fools here. But that was the one that pushed me over the fence, like, “Yeah, let’s wait on this one.”

Lewis: Yeah, I can understand that. [laughs] There’s some red flags there.

Solitro: There’s so many great tech companies out there, I didn’t have to force this one.

Lewis: I feel you. OK, we’re going to talk about Datadog, a company that just went public this week, we had to get up to speed quickly on this one because shares just hit the public markets this week, Joey.

Solitro: Datadog is a monitoring and analytics platform. What they’re doing is, they give you a real-time insight into your company’s entire technology stack. You could be looking at all your different servers, applications, all your different cloud-based softwares, and you’re seeing it in one spot. It’s almost like giving you a bird’s eye view of your entire organization. You know, if something’s going wrong, where it’s at, it allows you to search it. It’s basically that key player in digital transformation and cloud migration. It feels like every software company we talk about does the same thing. It’s focused on the digital transformation and making it better for customers or businesses finding your service. Datadog, they’ve made it easier, and put it all on one platform.

Lewis: Even as someone who follows this space — I know you and I both talked about this before — it can be tough to really separate what a lot of these SaaS companies do. I know that you have some tricks for getting to the root of, “Who’s truly the best in class provider here?” There are some company metrics that you can help do that with. I know that you like to ask around the Fool for some of the subject matter experts that work in spaces. You have a couple other tricks for, also, getting to the bottom of this stuff with online forums and things like that.

Solitro: How I’ll originally go through an S-1 is, I’ll completely ignore what a company does. I might know, it’s a tech company. I’ll look at the numbers first. And when I see over 80% revenue growth and net dollar retention over 140%, a growing customer base — everything about Data dog from the financial standpoint, I loved. Then I back into, now let’s find out what these guys do and what kind of competitors there are. Then, seeing, with the rise of data, and I think it’s going to be a five-fold increase in the amount of data companies have to be analyzing over the next 10 years, finding companies that can make sense of it, monitor it, and make the digital process easier, is key. So then I go to tech players here at The Fool. Of course, we use Datadog. Then I’ll check sites like G2 Crowd or Gartner Insights, and I’ll see what these other developers, people that actually use software, say about these companies. I think it was like 4.5 stars. I’m seeing all these as-good-as-it-gets ratings in comparison to their key competitors. So then I’ll look at the competitors. And yeah, it checks out, the reviews aren’t as good. They’re basically saying, because Datadog is unified platform, where all the other major players integrate within, it creates that all-in-one solution, which is another keyword, I always like to look for. All-in-one solution. They do what other people do, but they combine it all. There might be a competitor for a specific division, but not the entire company.

Lewis: It’s great to be a full service provider. It’s a pretty excellent space to be in. Listeners, tell us if you’ve heard this one before: they’re a SaaS company, they’ve got great margins, and they’re losing money because they’re investing heavily in SG&A. Is that pretty much the easiest way to sum up the financials, Joey?

Solitro: Yeah, pretty much. But I will say — this wasn’t confirmed by management or anything — I have seen that they do have previous years where they did reach profitability. I found a couple of different blog posts from insiders, but they wouldn’t confirm because they weren’t supposed to be saying it, but it’s like, three of the last seven years, they were profitable. And you look at the margins, they’re not burning a lot of cash, not losing a lot of money. It almost seems like they ramped up spend going into this IPO to boost those growth rates, which makes sense. But even then, their net dollar retention over the last 12 months was 146%. In 2017, it was 141%. In 2018, 151%. Those are statistics where I fell in love going through the financials. I don’t care what this company does, I’m going to find out a way to love it.

Lewis: [laughs] I think at some point, we may have to build a small shrine to the dollar net retention figure in the studio so that we can occasionally bow to it.

Solitro: Over 140%! That’s almost unheard of these days! There’s only a few companies. This one, and I think Twilio, and I think PagerDuty was up there, too. Those three companies lately got my attention. Definitely a great statistic.

Lewis: It’s the kind of thing you almost have to do a double take on. It’s proof. You go to the forums, and you read, “OK, this seems to be a best in class provider.” And that’s borne out in the metrics as well. You don’t get a number like that unless you are proving your value to customers and they’re increasing their spend with you.

Solitro: Exactly. I was going through the timeline of the company. It started as this base platform. They did one thing. Then they added another solution. And they’ve added three new solutions in the last three years. People trust the brand. They know that they’re very good at what they do. So then they’re like, “We added this to our platform. It’s an easy bolt-on. We think you want it, too.” That’s great to see. That could be the primary reason why we have these three great net dollar retention rates. That could be exactly why they waited to go public, so they could say, “Maybe 2016 was 120%,” or something like that; it couldn’t have been as great. But they knew, “If we ramp up spend, go public in 2019, we’re going to have some great statistics to show for it.”

Lewis: It actually brings us to an interesting point here. IPOs can serve a lot of different purposes. Companies can be looking to get a lot of different things out of IPOs. At core, they are supposed to be capital raising events. But it seems to me, companies like Zoom and Datadog in particular, I’m thinking about here, these were launch parties for these companies. I think people that were in these industries probably knew the businesses fairly well. But for people that are investors or just business enthusiasts, they were probably names that they didn’t know. But you start throwing some big numbers out there like this, you start ramping up your sales and marketing spend on the customer acquisition side, people are going to start to learn your name, especially when you’re going public.

Solitro: Absolutely. And yeah, I think that’s where a lot of these investment bankers come into play. They have their value for processes like this. But I also think, with how popular IPOs are getting these days, more retail investors are checking those IPO boards, seeing what’s coming, and actually clicking the S-1s. I think we’re doing a great job of spotlighting companies coming down the pike. For companies like Datadog, with these type of statistics — now, you wouldn’t think a cloud player would get as much attention as they have. But I think that’s just how we’re all growing as investors, and becoming more aware of the companies coming public.

Lewis: Yeah, we’ve been seeing all these headlines about private companies for such a long time. People are eager to get their hands on them.

One thing I did want to get your take on before we wrap up is, people will occasionally look at a company that’s gone public and say, “It’s trading 15% where shares were offered. That seems like a broken IPO to me.” I think that it’s worth diving into that and understanding the incentives of a public offering.

Solitro: I hate the term broken IPO or mispricing. If a company’s stock drops, it doesn’t mean it’s a broken company in any way. How I like to always talk about is, say you run a bakery. You spend years sourcing the right ingredients, perfecting your recipes. Then you go to open up shop. But then someone’s like, “We’ll do that offering to the public. We’ll run that front of the shop. We’ll buy your pastry for $10 that cost you $3.” And you’re thinking, “Holy crap, yeah, that’s a lot of money. Let’s do that.” Then you walk out on day one, and you look up at the board, and it’s $18. And you’re thinking, “How much money did I just leave on the table?

Now, if you do a secondary offering down the road, or anything like that, you might want that $18, where then they just jack it up to $24, whatever the market’s paying for it. That’s where I really encourage companies for these direct listings that they can — now, if they need to raise capital, by all means, price based on what the market’s saying. Seeing these big pops doesn’t mean it’s a great IPO. It just means those investment bankers and their very wealthy clients are now [wealthier]. You can see it as, these companies build themselves up over a decade, and then these investment banks make their clients as much money in one day as those people made over the last 10 years. I’m not a huge fan of these IPO huge pops, because I feel like they left more money on the table. But a company like Smile Direct, I think that is a phenomenal company, I bought it myself because I thought the market reacted incorrectly. To call that one a broken IPO just doesn’t make sense. They made more money on that day of the IPO. Sorry the investment banks and their clients don’t have as much money in their pocket as they did when they bought on day one. But hey, you have to lose sometime. If you’re not focused on the long term, then you shouldn’t have bought the company in the first place. But I’m looking 10, 25 years out, and I’m very confident with where I purchased.

Lewis: Yeah, there are different incentives for pretty much everyone along the chain. The one thing I will say with the broken IPO thing is, it’s a bummer when shares are finally publicly available, and retail investors get in, and they have a chance to finally buy a company like Lyft or Uber, and so often, those big names are people’s first experience with investing. They’re like, “Oh, I take Uber all the time! I have to get my hands on this, it’s a no-brainer!” And sometimes people get bit by that. And it’s unfortunate. It’s a painful investing lesson. But when you’re thinking about how companies raise capital, yeah, you want to be maxing out the valuation that you’re exchanging your equity for.

Solitro: Yeah, that’s the issue. Companies used to come public — I think Amazon came public in the third year of their existence. I think eBay was within the first five years. A lot of these companies used to come public so quick, because that was how they accessed capital. Now, there is so much dumb money in Silicon Valley. You could be raising a billion dollars, and you’re two years old. And hey, we can push off an IPO for 10, 13 years. Times have changed with how companies raise capital and where they can access it. It’s great for innovation. But for retail investors, we have to wait a very long time, and we might have to pay three, four, five times as much as we would if they would have gone public earlier.

But you always want to focus on the long term. I always say, take that 10-year stance. If you’re like me, take that 10-25-year stance. Take Datadog, it’s valued around $11 billion. 41X the last 12 months’ sales. Pretty hefty. But if they keep these growth rates up, if they can keep it over 60% over the next three years, that’s not that bad. If you’re focused on the long term, and you’re actually invested in the company, not just for the next earnings report, then I think you’ll do well.

Lewis: We talked about three companies. Before we wrap up here, I do want to ask you, I’m going to have to force rank those. Where are you putting them? Which one’s your top choice here? Which one are you a little bit less excited about?

Solitro: I had a feeling you would do that. I own Smile Direct. I can say I did that because it was only trading at about 12X sales for over 100% growth. They have the highest growth of them all and the lowest multiple. That was an easy one for me. Then I would go Datadog. Yes, it’s more overvalued than Cloudflare. But I think the runway is more significant for them. Cloudflare, I feel like a lot of companies will continue to do this, I feel like I’ve read so much about these companies that enhance performance and give you real-time insight into mission critical applications. I feel like their competitive moat isn’t as significant as a Datadog. So, I would go Datadog number two then Cloudflare number three, even though Cloudflare has a, quotes, “better” valuation than Datadog.

Lewis: I think it’s reasonable to see the dust settle a little bit on some of the things that are outstanding right now with Cloudflare.

Solitro: Absolutely. I’m going to wait for both these to come back down to earth a little bit. Now, Datadog may never do that. Say they just blow out the earnings report then keeps raging on. Then I’ll be standing there clapping and rooting for them. But Smile Direct’s the one that I could see the long-term runway and actually get behind the valuation think and think the market has this one wrong.

Lewis: What’s the investing maxim? You pay for quality? [laughs] You know? When businesses are putting up good results, you’re going to have to pay a premium. Joey, thanks for hopping on today’s show!

Solitro: Thank you very much for having me!

Lewis: It was a pleasure. Listeners, that’s going to do it for this episode of Industry Focus. If you have any questions or you want to reach out and say hey, you can shoot us an email over at industryfocus@fool.com, or you can tweet us @MFIndustryFocus. If you want more of our stuff, subscribe on iTunes, or even catch a ton of bonus stuff over on YouTube. There’s actually a video on our channel breaking down all the different elements of the IPO chain and the incentives there. Check that out. As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don’t buy or sell anything based solely on what you hear. Thanks to Austin Morgan for all his work behind the glass today. For Joey Solitro, I’m Dylan Lewis, thanks for listening and Fool on!

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