Should I invest in IPOs?

Any investor would love to travel back in time and load up on shares of Apple when the company went public in December 1980. Many millionaires were minted that day. Ten years after Google’s 2004 initial public offering, the stock had risen more than 1,000%.

But, as you are no doubt aware, initial public offerings for companies like Apple and Google aren’t exactly the norm. And the vast majority of profits for those companies and their investors came after the dust of the IPO had settled.

So, should you invest in IPOs?

When investing in any company, whether it’s private, on a public exchange, or one that is about to IPO, the most important thing is to have an understanding of the company, its products, and the way it makes money.

IPOs vs. established companies

With public companies, that’s much easier to do because they must disclose their financials to the SEC, which in turn makes the filings publicly accessible.

That’s not the case with a new company. Without such filings, investors can’t look through results over the course of several quarters to get a handle on their trajectory.

Additionally, IPOs have a tendency to trade on expectations and hype rather than on fundamental business principles.

Many people have made good money in buying IPOs, but statistically speaking, most companies have their share prices drop immediately following an initial public offering.

IPOs and the great hype machine

“Expect [a big-name IPO] to come out of the gate on the first day looking very hot,” wrote Fool co-founder David Gardner in a board discussion about IPOs. “That’s because standard practice is to underprice the actual money-raise so that the stock when it hits the exchange has a great first-day story. … Also, note that you won’t get to participate in that ‘30% Gain First Day!’ because the gain is typically as of the first second of the day. The people selling are those who owned pre-IPO shares; the people buying would be you and me, if we’re interested in the company, paying a big premium.”

As top Foolish member Fuskie added to that board conversation, “I’m not a fan of IPOs in general. There’s a lot of hype whipped up by the company’s PR machine and that of the underwriting financial institution who are in position to make big money if the stock takes off. Meanwhile, the individual investor usually gets trampled. They want you to think that if you buy the day the company goes public it will rocket and you will pocket mega-bucks.

“My suggestion is to give newly public companies at least 6-12 months to showcase what kind of public company it will be,” Fuskie continued. “That gives you time for the speculators to get out of your way and for the insiders holding period to expire before they begin dumping shares to realize their paydays.”

The allure on buying into an IPO can be strong, particularly if you want to use it in your cocktail party banter. If you want more information about an IPO, either as an investor or to sound really smart, take a look at www.renaissancecapital.com.

But in general, we advise you wait to invest until you have a chance to learn more about your potential investment. Invest in the company and not in the IPO, wrote Fuskie — if you believe in its long-term potential, there won’t be any significant difference in upside if you get in on the first day or once the dust has settled.

In the meantime, there are tons of companies that are already being publicly traded that offer clearer benefits to investors. Check out our newsletter services if you’re looking for some of those.

— Answer provided by Motley Fool member Jeb Sturmer

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