IPO or Not to IPO?
- If you are lucky enough to get in on an
IPO, you should not pass it up
- This is your golden opportunity to get
- You do not need to go through the usual
due diligence, after all IPOs are good investments
Not so fast! As with any investment, do it wisely
and do not act on impulse.
An IPO is an Initial Public Offering, a
company’s first sale of stock to the public. Typically, an IPO involves the
stock from a young and oftentimes little known, if not obscure, company. These
MicroCap or SmallCap companies go public in order to raise money. In so doing,
the company helps itself by increasing its financial base, liquidity, prestige,
and ability to attract management and make acquisitions. But, once public, the
company must now share the profits, be accountable to shareholders, relinquish
control over how the company is run, and disclose "secret" company
The process begins with investment bankers, who
underwrite the IPO. After researching the company and preparing a prospectus,
the investment bankers promote the company and pursue buyers. Generally, their
target is not the individual investor, but large institutional investors. By
carefully choosing IPOs they think will succeed, the underwriters can put aside
shares for their large clients, offering substantial profits for these favored
What this means to the individual investor is
that if you can get your hands on an IPO, it may not be the opportunity you
hoped for. Of course, there are exceptions, so do your homework before passing
up what might be a good buying opportunity. If you are determined to try to get
a piece of an IPO, you basically need to have an account with one of the
underwriters. Check with your existing broker first, and then check the offering
prospectus for a full list of underwriters.
If you cannot get in on an initial offering, it
is good advice not to buy shares of an IPO on its first day of trading. More
often than not, they are selling at an inflated and unsustainable price. If the
stock is worth owning, it will most likely be worth owning weeks, months, or
even years after the initial hype has died down.
Many IPOs will experience a price run-up
immediately after they start trading, only to come down to a more rational level
once the buzz dies down. One study showed that investors who bought shares of an
IPO at the closing price on its first day of trading saw a 2% annual return on
On average, IPOs make bad investments. A study by
two university professors a few years back looked at 4,753 IPOs and 3,702
secondary offerings made between 1970 and 1990. In the six months following the
offering, IPO firms lost 1.1%, versus a 3.4% gain for matching firms that made
secondary offerings. During the 20 years covered by the study, the average
annual return over the five-year period following the offering was 5.1% for the
new issues and 11.8% for the comparable firms.
The bottom line is you do not invest in an "IPO",
but in the company being offered. And, like any other company you invest in,
research them and make an educated decision on the company, not the "IPO".