The truth about IPOs?

Straight to the point: They are usually bad investments.

Sure there are ones that have done well, *Ahem Microsoft:

Microsoft went public on March 13, 1986. If you had bought 100 shares during the Initial Public Offering:

microsoft-IPO-initial-public-offering

Screenshot from http://www.microsoft.com/investor/Stock/StockSplit/stockcalc.aspx Current value is dated as August 6, 2014

Microsoft has certainly done well. For every Microsoft however, there have been thousands of other IPOs that have ended up biting the dust.

Everybody wants to buy the next Microsoft. Unfortunately the fact is that we missed out on that money train. The truth is that most IPOs are awful investments.

And I will tell you why.

Lack of Information

A lack of historical data makes it hard to analyze the company your investing in. It’s hard to determine their value and how they will fare in the future. The best information you have available before a company goes public is the red herring prospectus. But even that won’t give you a solid idea of how well the corporation will do in the future.

Members Only Clubs

I hate these. A place where only the ritziest, pompous assholes can hangout while the general public are building mental images of what’s on the inside. No wonder people get excited when a private company goes public; a private club has opened it’s doors for everyone to enter.

When a stock goes public, some people may think that it’s an opportunity to get first grabs and be involved early on in the company. What you don’t know is that on the inside they probably already went through a few rounds of private investment before going public. So by the time you buy, the price per-share has already gone up. What’s worse is now these ‘members only’ can sell their shares to the public at a higher price.

Hmm sounds similar to a Ponzi Scheme doesn’t it?

Special Salesmanship

A company works with an investment bank when they want to go public. Underwriting is a process where the investment banks purchase securities from a issuer and sell them at a higher price to the general public. The difference between the prices is known as the underwriting spread.

Understandably, the underwriters goal is to make a profit. They are taking on the risk and have to increase prices for reward.

New issues of common stock are usually sold with an “underwriting discount” (a built in commission) almost double that of older shares. When Wall Street is making double to sell something new as they do selling something old, the push is obviously going to be the former.

Market Conditions

Most IPOs are sold under favourable market conditions, but not in terms of the buyer. It is said that most corporations offer new shares to the public when the stock market is near it’s peak. There’s interesting information in The Intelligent Investor: The Definitive Book on Value Investing that shows the relationship between IPOs and market timing. From what I have read in the text, the first thought that came to my mind was:

A History of Craziness!

In 1825, during America’s first IPO boom a man was allegedly trampled to death in a stampede of speculators fighting to buy shares in the new Bank of Southwark. Thugs were hired to “punch their way to the front of the line.” By 1829 the stocks lost roughly 25% of their value.

From the dates June 1960 through May 1962, over 850 companies went public on the stock exchange. Later in 1969, a total of 781 IPOs were introduced. This over saturated IPO market brought about the bear markets of 1969 and 1973-1974. A grand total of only 9 new stocks were created in 1974; only 14 were introduced during 1975.

Now this undersupply assisted in bringing about the bull market of the 1980s, during which time around 4,000 IPOs hit the market. This raging enthusiasm helped to bring about the 1987 crash — which was followed by you guessed it — a bear market barren of IPOs.

Ah the 90’s! Great decade right? I learned how to walk and talk while Wall Street was back pumping out almost 5,000 new issues. Then the millennium hit, along with the end of the raging bull market of the 1990s. In 2001 only 88 IPOs were introduced.

I gathered these numbers from Jason Zweig’s foot notes in The Intellegent Investor. The facts go to show that companies mostly come out to play when the bulls raging; toro toro!

Jason Zweig also has a comment in the book I enjoyed:

Weighing the evidence objectively, the intelligent investor should conclude that IPO does not stand only for “initial public offering.” More accurately, it is also shorthand for:

It’s Probably Overpriced,

Imaginary Profits Only,

Insiders’ Private Opportunity, or

Idiotic, Preposterous, and Outrageous.

I love the lambent wit he shows in his commentary…

Conclusion:

The average investor shouldn’t worry too much about getting their hands on the next ‘hot IPO’. The only way for an individual to get shares is to have an account with one of the banks involved in the underwriting. Even then you have to have your “frequent investors miles” logged if you want to be considered. Small investors get the economy seating, and if you get the chance to purchase IPOs the bigger players probably didn’t want them. Your chances are very slim unless you’re on the inside.

But I hope this article goes to show that even though it’s nearly impossible, they are usually bad investments anyways.

 

Later days,

-Jason 

 

 

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