Stocks: Should you invest in IPOs?

Flocking to an initial public offering is no sure route to profit, said Aaron Pressman in Yahoo.com. “Without a doubt, the market for technology IPOs is hot.” On Twitter’s first day on the market last week, its stock started trading at $45.10—73 percent above its $26 IPO valuation. But very little of that quick profit went to amateur investors—which is why they’re better off ignoring marquee IPOs. “Wall Street firms allocate most IPO shares to their biggest and most profitable customers,” meaning big hedge, pension, and mutual funds. Those buyers cash out quickly “as soon as the shares start trading,” leaving the rest of us to buy only after “gains are already priced in.” So be wary if your broker calls to pitch IPO shares. When “underwriters of a supposedly hot IPO suddenly start flogging shares to the general public ahead of the deal,” it’s more often than not a signal that “the smart money has doubts about the company or that underwriters are selling more shares than the market can absorb.”

It’s a remarkably stubborn myth that investing in an IPO always “gets you in on the ground floor,” said Brian Hamilton in -BusinessInsider.com. Instead, it’s a matter of “coming in on something like the fifth floor”: By the time a company goes public, you’re already “late to the party.” If you’re tempted, consider that investment banks, analysts, and private investors talking up a company’s first public shares doesn’t mean they’re necessarily a good buy. “Companies go public for a variety of reasons. Financial strength is, unfortunately, not always one of those reasons.” That’s why any investor should closely study a company’s financial performance and valuation. “If it’s profitable and growing, then maybe the first-day price on the exchange is a good one.”

If you can secure that initial price, an IPO is “almost a free lunch,” said Nigam Arora in MarketWatch.com. “Well-priced, high-profile IPOs tend to trace a pattern of higher lows and higher highs.” If you buy into one that doesn’t show that pattern, sell right away; you’ll still make a small profit, even if the IPO burns out. As long as demand exceeds supply, that pattern will persist, and “a trader can simply continue to hold shares.” But it’s only if you’re lucky enough to be a favorite client of a broker and can get a piece of a hot IPO early that “the risk-to-reward ratio is dramatically skewed to the reward side.”

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