Buying Stock at IPO

The IPOs generally give investors a wild trip in relation to returns. In September 1998, eBay and Internet company, were introduced in the market at an $18 issuance price, and 3 and a half months later the stocks were being negotiated at $246 per each. This 1,267% return only took 3 and a half months; however not all IPOs are like eBay. Many investors have burnt themselves in the IPOs market.

One of the greatest losers in 1998 was the USN Communications that was introduced to the market at $16 per stock in February and finished the year at a lower price $0.31 per stock. They had a 98% loss per each.

Investors that allocated orders in the market in the first day of negotiations for the new Internet and Globe .com issues also got burnt. Stocks were first offered at $9 each and later they were raised to $97 each only to drop afterwards to a low double digits in its first day of negotiation.

Investors that had their orders filled in with those high prices were surprised and deceived when stocks ended up being negotiated at around $5 each by the end of December 1998. Globe.com is no longer in business. Palm, Inc. is another example of an extraordinarily short term return IPO and with a real bad long term return. The day Palm entered the market during the first trimester of 2000 it was shortly negotiated at $165 price per stock. Two years later they negotiating each stock in $1. A 1-for-500 reverse stock split subsequently took place to raise the price of the stock.

You should not be blinded by the spectacular returns of some IPOs because, generally, IPOs long term returns are usually frustrating.

A study made by Christopher B. Bary and Robert E Jennings in 1993 show that great returns earned by IPOs usually happen in the first days after being introduced in the market.

Professor Jay Ritter concluded that a long term IPO has a lower performance than those stocks of negotiated companies in the secondary market (negotiated stocks existing in markets). Besides, Wall Street practices of imposing penalties to those brokers that sell to their clients stocks that have just been introduced in the market is a disadvantage for those small investors.

Investors that bought stocks in the after-market in the first day of Lazards negotiation in May 2005, for instance, saw how these closed below the range of offers in its first day of negotiation. A reason why IPO stocks drop in their market prices after a certain time could be within the same company and due to employees selling their company shares.

Executives, managers and employees of a company can buy stocks or be given the option. Employees normally must keep their stocks for a fixed time period  known as lock-up period which generally is three months or a year. When the lock-up period expires employees can sell their stocks causing prices to drop. The IPOs market have some disadvantages of which you be prevented before investing:

  • Group investors buy large amounts of stocks leaving a small amount to be bought by individual investors.
  • Group investors are better informed than individual investors
  • Individual investors generally get their information through brochures while group investors can go to road-shows and learn from company executives. Cheat sheets that provide brokerage firms to their preferred group clients, bring administrative forecasts and income projections that are not shown in brochures. Companies are reluctant to include these cheat sheets in their brochures for being a public document, and because if these published projections are not accomplished they could be sued.
  • Individual investors are penalized for selling their stocks immediately after its issuance, although if group investors have the respective permits to get rid of their stocks quickly.

If you want to participate directly in the IPOs market, you should be aware of disadvantages. On the other hand, you could consider mutual funds concentrated in IPOs.