IPO Investing – Easy Money or Waste of Money?
Before you jump on the fad van of Initial Public Offering or IPO investing you may need to understand a few things about what this is and how it works. As an advisor, I have clients call me up and told me to invest a certain amount of money in a new IPO that they said their friends were doing.
So, by their direction, I did the trade on the day of the IPO. More often than not, they lost money in the short term as the initial fanfare faded away.
You can do a google search on the biggest successes and biggest failures of IPO’s over the last 10 years.You may also want to consider what sector the company is in that is offering the IPO. Is it in energy, or medical or technology or what? Then look at these sectors as a whole to see how they fare in the market.
Is the company a regional or national or global in its reach before the IPO? Answering some of these questions as you research is extremely important.
The point is that none of the investors knew for sure how it would go before the IPO. If you remember the technology bubble of the late 1990’s, you will know that anyone could pick just about any technology stock and make money on it on paper. Then they lost it all when the bubble burst.
Let’s get some understanding now about IPO investing.
Whenever a privately held company believes it has built a big enough business to go from private to public and needs money, the best way is to offer itself under an IPO. They hire the investment banker to create the details of the offering, the tombstone literature gets the broker-dealers on the venue who will market it and the clearance with the SEC.
They most likely will offer so many million shares and keep a few million or more for themselves on the offering. Once the IPO hits the market, the company makes the initial money off of the offering.
That is the only time that the company makes money on these sold shares. Investors can then buy and sell them on the exchange, and not one penny goes back to the corporation.
The only way that the corporation can make more money after the IPO is by selling off the shelf stock that they have into the market or creating a stock split from these shelf stocks. This creates a dilution of existing stocks which may not benefit the existing common stockholders.
In addition, a private corporation that was very successful that offered an IPO is now a public corporation that is subject to many more market forces, regulatory effects and higher scrutiny than before the IPO. The Sarbanes-Oxley Act comes to mind. This can all have the potential of creating a devaluation of the stock in the short term after the IPO.
So can you make money in an IPO? Is IPO investing for you?
The answer is it depends on. It depends on many market forces. The best way for you as an investor is to do your own homework, read the tombstone offering and prospectus. Decide ahead of time that if you are going to invest in an IPO, it is as solid a company as you can reasonably expect and plan to hold the stock for at least 3-5 years.
Your chance of making money on an IPO will go up if you have the long-term mindset of owning this company like any other in your stock portfolio.