The term "IPO", or initial public offering, conjures up images of
millionaires being created overnight during the halcyon days of the
internet bubble. It was quite common to see unproven technology and
growth stocks shoot up 300-400% on their first day of trading, making
executives instant multi-millionaires.
Unfortunately, many
small investors got burned by buying these stocks with the hopes of
finding the next "Microsoft". Too often, investors found the next pink
sheet stock. The IPO market doesn't have to be off limits to growth
investors, but there are definitely some prudent moves you can make
before you dive in.
Early Bird Catches the Storm
Unlike most things in
life, being early to a hot IPO can be disastrous. Unless you were
allocated some shares at the actual opening price, it is best to wait
until the initial hype dies down, because you will likely be buying the
shares that the big boys are selling on the first day.
If
indeed the company is worthy, there is no need to rush to get in.
Holders of Microsoft had many years to get in before the stock really
took off. Companies that receive a lot of hype before the IPO date are
often "oversubscribed", which means the demand for their shares will be
huge on the first day. These are the ones to avoid buying right away,
as the investors will be flipping the shares rampantly.
Don't Get Locked Up
Speaking of patience, you should be
aware of when the lock-up period ends, and think about buying
afterwards. The lock-up period is a legal contract (usually between
three to 24 months) between the underwriters and insiders of the
company prohibiting them from selling any shares of stock for a
specified period of time.
The share price often drops as soon
as the lock-up ends due to a flood of insider selling, but this is when
the true believers are revealed. Insiders who hold their shares could
be hinting that good times are ahead. Holding shares through the
lock-up period is a vote with their wallet that they have confidence in
the future. This could be a good indication for you to follow suit and
buy.
Back to Basics
Many people ignore a company's
prospectus, but they do so at their own peril. This boring, yet
important read contains vital information regarding the company's
prospects (hence the term "prospectus"). It states in plain English the
company's risks and how it intends to use the proceeds from the initial
public offering. You should take notice if the company doesn't use the
money for research or expansion of some sort.
Common Sense
The main thing is to use common sense when
investing in IPO's. Don't gamble with hot, unproven companies that are
up 400% on the first day, especially without reading the prospectus and
knowing what the company is all about. There will be plenty of time to
profit once the hoopla dies down. Just ask the insiders of Microsoft.p
