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Is IPO Investing For You?


Before you invest in an IPO, understand that new issues are by definition untested stocks and therefore speculative and risky.

Online brokers have opened many IPOs to individual investors, but the process is still dominated by institutional buyers.

This demands caution from The Little Guy when thinking about IPOs.

The company going public and its underwriters retain extensive control over the allocation of shares, making it difficult for individual investors to get in on many hot deals.

It's a matter of putting the shares in the right hands – not a grand conspiracy. The underwriting syndicate agrees to buy the initial shares from the company and then offers the shares to investors. The number of underwriters invited to participate in the syndicate is limited and participants may not receive an equal number of shares to offer their clients.

The underwriters want to sell the shares as quickly as possible. Remember: This isn't the National Endowment for the Arts. In most cases, the need to make a quick profit means institutions such as mutual funds and major investors who can tolerate the risk that comes with buying into a new, unproven company.

The underwriters' decision to offer shares in hot IPOs to their best clients is often derided as "spinning" the shares to a favored few. But keep in mind that these clients also buy shares in so-so deals.

The underwriter helps the company going public write the IPO prospectus, a detailed discussion that includes a description of the company, its financial performance, use of the money raised in the deal, competitors and the experience of top management. This is called the "red herring" in the trade, perhaps because of the red disclaimer across the top of the cover or maybe because it can be so artfully written. Use the preliminary prospectus as the starting point for your research – not the final word.

It appears that the size of many IPOs has been increased to meet retail demand, but the number of shares offered to individual investors is still much smaller than number of shares offered to the major institutions. In general, the allocation of IPO shares is about 80% institutional and 20% retail.

Some brokers require a minimum cash balance in an account before considering an individual investor for an allocation of IPO shares. Some firms won't offer future IPOs to individual investors who flip, or quickly trade their shares for a fast profit.

The "open" or "Dutch auction" IPO pioneered by WR Hambrecht is an attempt to open the process up to individual investors. The Dutch auction allows individual bidders, not the lead underwriter, to determine the value of a company's initial shares. A company going public determines how many shares it wants to offer and sets a price range. Individual investors then make bids. When all bids have been submitted, the company allocates shares to those who bid at or above the minimum price set by the company.

Despite the allure of cutting edge technology and a quick profit, IPOs aren't suitable for most retail investors. Most individuals trying to track down and invest in hot IPOs will be about as successful as a fan in the cheap seats who puts down his hot dog, takes another swill of beer and trots onto the field to hack away at a 95-mph fastball followed by a wicked curve and slider.

Before you invest in an IPO, understand that new issues are by definition untested stocks and therefore speculative and risky. Also know that Wall Streeters are like 20-game winners with unhittable stuff when it comes to experience, research, insight and access to the strongest IPOs: dominant.
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