"I plan to invest my life savings into the Google IPO. How do I go about buying shares?"
This is one of many emails I get from investors who come to my site, CurrentOfferings.com, which caters to IPO investors. I have followed IPOs for more than 10 years, having written a book on the subject, been on many conference panels, talked to the press, and even invested in new issues. Never have I seen anything like the Google IPO.
Traditionally, IPOs have been mostly for the professional investors and the wealthy. This is seen as yet another example of elitism that needs to be reformed (and that's Google's philosophy).
However, there may be a good reason to leave IPOs to the pros: They are usually quite volatile.
This should be the same for Google. For the rest of the year, fundamentals -- such as the emerging competition from Yahoo!
Let's take a look:
The hype period
During the Roaring '20s, it was the insiders and Wall Street professionals that had a virtual monopoly over information about companies, and it meant that the fat cats got richer and richer.
After the 1929 crash and the Great Depression, the public was outraged, and Congress responded by passing the Securities Act of 1933 to level the playing field for IPOs.
For example, Congress prohibited "gun-jumping," which is when a company hypes its offering to try to boost the stock price. The gun-jumping rule made sense years ago, when prospectuses were sent via the mail. But, of course, now we live in the age of instant communications, making the rule a quaint anachronism.
Yet the Securities and Exchange Commission is nonetheless enforcing gun-jumping, as seen with the recent case of Salesforce.com
This anti-disclosure period -- known as the "quiet period" -- was actually increased a few years ago from 25 days after the IPO to 40 days. After this, a company can get aggressive with the media. Moreover, analysts of the company's underwriters can start initiating research reports, which of course are nearly always positive.
The irony is that the quiet period is more accurately the "hype period." Because of the regulations, companies are deathly afraid of making disclosures. On the other hand, investors want to get information; that's the nature of markets. Information is oxygen for financial markets.
We have seen recent examples of how the quiet period encourages volatility. Look again at Salesforce.com. When the company came out of its quiet period, it announced its guidance for earnings. The stock plunged 27% on the news.
The media said the company missed its prior guidance. Yet the company had provided no such thing! Instead, it was the press that was providing the guidance to investors -- and, inevitably, it was wrong.
As for Google, the hype is magnitudes larger than it was for Salesforce.com. And Google has indicated it will not provide guidance to Wall Street. In other words, the few days before the release of Google's quarterly numbers will likely be nail-biting experiences for investors.
Floating-point mathWhen a company goes public, it will issue only a percentage of its total amount of stock in the offering. To do otherwise would flood the market with too many shares, driving down the stock price.
This means that an IPO will typically have a small float (the number of shares tradable on the market). If an IPO has excessive hype and a small float, it means the stock price will surge. It's really a simple matter of supply (shares) and demand (investors willing to take a flier).
This has been the case with Taser
Google's float will be 26.4 million shares. Assuming the stock trades at $135 per share, the value of the float will be roughly $3.5 billion.
While this sounds like a big number, it is only 9% of the total value of the company. By comparison, Yahoo! has a float of 1.2 billion shares valued at $37 billion. Despite the massive float, the stock is nonetheless a volatile issue.
Hedge fun at your expenseAnother factor driving up demand for Google shares will be hedge funds, which have a tremendous amount of buying power to move a $3.5 billion float.
Hedge funds are pools of capital whose investors are primarily institutions and high-net-worth individuals. Basically, this is the crowd that buys IPOs.
Hedge funds having difficulty finding strong returns gravitate toward IPOs. IPO volatility means the potential for higher returns. Yes, it's kind of like a casino, but that is not a problem with many hedge fund managers. Either you thrive or die. Why not take the big risks?
What's more, hedge funds can add more to the volatility by employing sophisticated investment techniques, such as short selling. This is the process of making money when a stock falls in value.
Here's how it works: A hedge fund manager borrows 100 shares of Google from another investor and sells the stock on the open market. If the stock price is $100, then $10,000 is deposited into an escrow account. If Google falls to $50 per share, the short seller will buy back the 100 shares for $5,000 and take the $10,000 out of the escrow account, making a $5,000 profit.
Interestingly enough, this increases the float of the stock. How? The investor who loaned the stock to the short seller still owns the 100 shares. And the short seller sold the stock to another buyer. So the float has increased by 100 shares.
The increase in float may help reduce the stock price, at least in the short run. Then again, if the stock price surges, the investor who has the 100 shares may decide to sell his shares. This means the short seller needs to deliver 100 shares back to the investor, which means buying them on the open market. This provides increased demand for the stock and creates a "short squeeze."
The Google IPO offering is a game for the pros. It's not for individual investors. Be patient, and reevaluate at the end of the year. Google may be a great company, but don't let yourself get caught up in the hype of Google's public debut.
Fool contributorTom Taulliis the author ofThe EDGAR Online Guide to Decoding Financial Statements. He does not own shares in any of the stocks mentioned. The Fool hasa disclosure policy.
