One of our readers asked me the following questions: “How about those companies doing an IPO, are they good to invest at? You will become one of the firsts to buy their stocks, does it mean that the share price is initially cheap?”
I apologize for taking a very long time to write again. In fact, I forgot who asked this question. I usually contact readers asking a question and inform them that I have now composed an answer. Anyway, whoever you are asking this question at least you now know, that I have not forgotten your request.
So should you get a Flexible Mortgage and invest in an IPO ? Llet me answer the above question simply and straightforwardly, the answer to both questions is both a YES and a NO.
For those who are new to stock market investing let me first discuss what an IPO is. An IPO stands for “Initial Public Offering.” Wikipedia defines an IPO as one “ . . . when a company (called the issuer) issues common stock or shares to the public for the first time.” The most popular reason why a company offers to sell its shares of stock to the public is to raise capital. But Wikipedia list other reasons such as:
- Bolstering and diversifying equity base
- Exposure, prestige and public image
- Attracting and retaining better management and employees through liquid equity participation Facilitating acquisitions
- Creating multiple financing opportunities: equity, convertible debt, cheaper bank loans, etc.
- Increased liquidity for equity holder
So now that you know what an IPO is, let’s go to answering the question and why I am answering both YES and NO to both questions. Let’s go to the “NO” part first. Here are some reasons why you should not invest in an IPO
1.) IPO – Read this – I-t’s P-robably O-verpriced
Yep, that’s right, most IPO is not only probably overpriced, its SURELY OVERPRICED ! Let me give you two reasons for this:
a.) Thinking like a business man - To really understand this, let us put on our business thinking caps and think like a business person. Here you are, owner of a small to medium size company operating for several years and most likely growing in size and income. Why are you listing publicly? Because you want to expand and you need capital for this. Why do you want to expand? Because there is a demand for your product or service or that there are business opportunities you want to exploit. So if you are the owner of this business, would you sell your business for less than what it is really worth? Of course not! It would not be logical. You would not even sell it for what its assets or book value is worth, you would sell it at a premium! Would you just allow other investors to take part in the growth of your company without them even participating in the “growing pains” of the company? You would only allow that if they pay you a premium for it.
b.) Blame it on the “underwriters” – The company offering its shares enters into contract with an underwriter (one or more investment banks) (Read underwriter not undertaker) to sell its shares to the public. The underwriter then approaches investors with offers to sell these shares. The underwriters keep a commission based on a percentage of the value of the shares sold. Of course since it is the underwriter’s job to ensure that an IPO is successful they have to make sure that the price is attractive to the public, however they have also to make sure that the price is attractive to the company. The underwriter is the “promoter” of the stock, so they have the tendency to paint a “good picture” or a rosy outlook of the company’s prospects hence increasing the tendency to further jack up the initial stock price.
2.) Study shows why you shouldn’t invest in an IPO
To support this point let me directly quote from the book “Stocks for the long run” an excellent book on stock market investing by Prof. Jeremy Siegel:
“While many investors recall the newly-issued story stocks, such as Intel, Microsoft, and Wal-Mart, which have made investors rich, most forget about the many such firms that fail to fulfill their promise when they are issued. A study by Tim Loughran and Jay Ritter followed every operating company (almost 5,000) that went public between 1970 and 1990. Those who bought at the market price on the first day of trading and held the stock for five years reaped an average annual return of only 5 percent. Those who invested in companies of the same size on the same days that the initial public offerings (IPOs) were purchased gave investors a 12 percent annual return. . . ”
So there you have it ! Here are the supporting reasons on why investing in an IPO is a “NO.” Want to know when you should say “YES” to investing in an IPO ? Find out more in “Should you invest in an IPO ? – Part 2”.
Hi ! my name is Zigfred Diaz, Thanks for visiting my blog where you can learn stock market investing the Warren Buffett way and using other value investing methods ! Never miss a post from this blog. Subscribe to my full feeds for free. Click here to subscribe to The Polymath Investor by Email