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Initial Public Offerings

Initial Public Offerings (“IPOs”) are the first time issuance, by a company, of its common stock to the public.

Generally, IPOs have under-performed the stock market averages for the last 30 years. The troubling statistic to investors is that the majority of IPOs are trading “under water” two years after they start trading on the stock exchanges. This seems to be a natural phenomenon for companies that go public. When going public, companies are thoroughly analyzed by the investment community and only the best ultimately go to market. By the time an IPO closes, the company has been heavily marketed, creating a pent-up demand for the stock.

Then, in some cases, the media takes over, further promoting the “first day bounce” in the stock price, creating even more demand. Eventually, the stock settles down to its fair value.

Compounding the extreme marketing push by the underwriters, normally when a company raises equity, it has a history of growth and a story to tell, in terms of business opportunities. Growth is always hard to sustain, and when it falters, usually within the first two years of having an IPO, the stock price falls back in line to its fair value, causing the initial purchasers to lose money.   

Getting in IPOs at the initial offering price, and “flipping” the security quickly when there’s a run up in price, is a strategy that is often used by investors. The downside to the flipping strategy is that you may sell a Microsoft-type investment. 

Investing in IPOs is no different than in any other stock. Your initial purchase price must be reasonable for there to be a chance to make a profit. I always refer to a friend of mine who purchased Genentech at its high on its first day of trading at the IPO date. She wanted to get in on a “ground floor” opportunity. She then held the stock for almost twenty years. While she picked a great company, it was a mediocre investment, because she over-paid on the IPO date. In general, one needs to be very selective and cautious with IPO’s.

Recently, a new development has occurred. Private equity firms have been buying companies with proven cash flows, loading them up with debt, partially cashing out by declaring dividends, and then monetizing the remaining investment through an IPO. Since this technique is not time tested, investors need to be careful if participating in these securities.

 

 

 

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