Should You Be an Instant IPO Investor?

Imagine investing in shares of the following companies when they debuted:

Data: Yahoo! Finance. Returns based on closing price on first available date after IPO.

Those exciting numbers show why many investors start salivating at initial public offerings (IPOs) -- when companies first begin offering shares on the open market. They also explain a relatively new exchange-traded fund (ETF), one focused on IPOs. Meet the First Trust U.S. IPO, tracking the IPOX-100 U.S. index, which is composed of the 100 IPOs during the past 1,000 trading days with the biggest market capitalizations. Its top holdings currently include Visa (NYSE:V), MasterCard (NYSE:MA), and Philip Morris International.

To some people, this is a promising time to get into IPOs. They reason that the market will eventually be getting in gear again, and when it does, companies that have been putting off their IPOs will launch their shares. During bull markets, IPOs can sometimes soar (at least briefly).

Hold on ...
But not all IPOs perform spectacularly. Look at General Electric's insurance spinoff, Genworth Financial (NYSE:GNW), down some 62% since debuting in 2004, or 2006's telecommunications concern Vonage, which has lost more than 97% of its value. One research study that looked at nearly 3,000 IPOs between 1968 and 1998 concluded that average rates of return are usually disappointing and often negative.

Typically, only a select few can get into an IPO at its relatively low initial price. Others buy in later, at higher prices. After a few months, especially after the expiration of an insider lock-up period (during which insiders are not allowed to sell their shares), shares will often sink back to lower levels. Sometimes it's best to just hang back and wait for IPOs to settle down before you invest.

If you do decide to invest in them, be choosy. Yes, many will be unspectacular performers. But some will shine. That's one of the problems with an investment like this ETF -- the effect on the fund of IPOs that shine will be diluted by the performance of less-stellar companies. You won't find me among this ETF's investors.

Learn more and gather investing ideas:

• It's Finally Time to Buy These Stocks
• Doomed Stocks You Should Avoid
• The Sweet and Sour of IPOs

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