Broker Check

Just say "No" to IPOs

| May 20, 2012
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Last Friday the 2nd largest IPO in US history (VISA- [V-NYSE] being the largest IPO launching in March 2008) hit the market with Facebook Inc shares (FB- NYSE) trading for the first time publicly. Many “regular” investors had been waiting for this moment to buy the stock, as the “privileged” investors (those granted shares at the IPO price of $38.00) had already been assured of their purchases. Indeed, a physician client’s wife phoned me just after the stock started trading Friday telling me her husband would like some shares. I had no intention on buying shares in my client’s portfolios that I manage and fortunately, after a ten-minute conversation I was able to discourage her from making the purchase. While shares hit in the $45 territory the first day of trading shares closed at $31.00 just two trading sessions later. What went wrong?

A number of things did not smell right after the FB launch on Friday morning, but that is not the point. As a rule, I would recommend to any long-term investor to avoid buying any IPO on the first days of trading. Yes, you will miss the scant “good deal” but you will save yourself many headaches in the end.

Issues with a new publically traded company (IPO):

  1. No track record of the stock
  2. No or very little credible public research available on the company
  3. Company founders are typically liquidating some/all of their ownership
  4. IPO price usually only available to institutional investors, not “regular” investors

Working 19 years for two major brokerage firms as a stockbroker, I learned one important lesson about IPOs: You will never get much if any allocation of the “good” ones. Let me explain. When a company hires an underwriter (Morgan Stanley in the case of Facebook), a price is set the night before the company first trades. This price, the IPO offering price, is the price at which all those granted an allocation would pay for the stock. The underwriter is the Santa Claus that awards the allocation to all the other firms, which then offers the shares at the IPO price to their clients. The Branch Manager of the retail brokerage firm office then awards shares of the IPO to the brokers in the office. As a broker, you would always hope to get a larger allocation of shares. Sadly, on the good deals, our entire office might receive a token 50 shares of an IPO deal, and that would go straight to the big producer in the office. On deals that our office was allocated thousands or tens of thousands of shares, you knew that the deal was going to fall flat. The reason the retail allocation was high was that the institutional firms (the “big boys”) passed. Take away: As an investor, you do not want shares of any IPO under most any circumstances, especially if you are able to get the IPO price. Unless you are a prime client sitting on a multimillion-dollar account with a Goldman Sachs or Morgan Stanley, you are most likely getting a sucker’s bet if your broker offers you shares of an IPO at the IPO price.

The biggest problem with IPO investing is that it is emotional investing. The investor remembers the time the “big one got away” and decides that the next time that will not happen. I have seen normal rational people willing to invest a disproportionate amount of their portfolio in an unproven IPO because they “missed Google” or “missed LinkedIn”. Emotional investing almost always turns out ugly. Most investment mistakes are really investor mistakes. One reason my physician clients hire me is because they have no desire or interest in making the many investment decisions that make up their portfolio and would prefer using a professional instead. The best way to avoid investment mistakes is to hire a real fiduciary financial planner that has your interests at heart.

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