By Mickey Welcher
Recently SnapChat went public and shares closed up 44 percent in the first day of trading. The lucky investors who were able to purchase at the $17 initial public offering price made out well, but most had to wait until they could buy on the open market when the price was $24.
Here in lies the rub. Most of us can’t buy IPOs at the opening price. That’s because institutional investors, such as mutual and hedge funds, get first dibs. These are the people and organizations that spend millions in commissions and trading fees. In nearly all cases, this group will swallow up all the available shares, leaving nothing left for anyone else. On the rare occasion some shares remain, large clients who work with the institutional investors get the next right of refusal.
There have been cases, mind you, when some IPO shares become available to “Joe” and “Jane Average Investor.” Maybe your advisor calls on that once-in-a-lifetime day asking if you want to get in. You cannot believe your luck and “yes” shoots right out of your mouth. Be warned that these stocks are ones to avoid every time. If institutional and large investors passed on the opportunity, the IPO is almost certain to be a stinker. Second, you can’t sell the stock for 30 to 90 days. While the first group of institutional investors can sell it the moment it comes out, your brokerage firm will put you on the “do not sell” list — no ifs, ands or buts.
Facebook is a terrific example of the average investor getting burned on an IPO. The company went public with the highest valuation of any IPO, and many institutional investors sat on the sidelines. That meant a large supply of the stock became available to the general market at $38 per share. Facebook shot up the first day but then closed down nearly 11 percent the next day at $34.03. It then plummeted to $20 — or close to half of its original value — within the first 70 days. Only years later did the stock become the hit it now is.
Earlier this month we saw Spotify announce they are considering going public without doing an IPO and possibly go directly to the general public through the NASDAQ or New York Stock Exchange. This could be an interesting change in the IPO process, but it begs the question: Why would a company do this if they have such a great product and large institutional investor interest? Spotify is losing out on raising a lot of money through private equity firms and speculation could be that these groups are not warming up to the tech company’s IPO prospects.
Here’s my advice. If there is a hot IPO you want, wait to buy it. There are very few times that the stock does not come down after a strong opening and become more reasonably priced. Sometimes it takes weeks or months. Nevertheless, once restriction periods end and insiders can sell, more of the company’s shares hit the street and prices will come down.
The IPO market can be very enticing, but it only works for the big-market players. The small guys get left holding the bag. Be smart and don’t get caught up in the hype.
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