An initial public offering (the real words behind IPO) marks the first time a company sells its shares to the public. The opening price is generally set around 15 or 20 percent below the hoped-for market price, says Ian Zwicker, president of the online investment banking firm WR Hambrecht, in San Francisco. That leaves room for a quick and profitable pop, when the stock starts to trade.
Pop, schmop. Prices last year ascended on rockets, scattering stars. Led by the Nets and techs, IPOs set all-time records, says Jay Ritter, professor of finance at the University of Florida in Gainesville. On their first day of trading, they soared an average of 70 percent, compared with just 14 percent between 1990 and 1998. In trading after the first day (known as the aftermarket), last year’s gains averaged 69 percent. What’s more, a record number of profitless companies successfully sold stock.
Free money: So who gets this free money–the $15 stock that could zip to $50 the first day it trades? Bend your ear while I whisper: not you. Up to 85 percent of it goes to institutions, such as mutual funds and pension funds. A handful of brokerage firms get the rest to allocate to customers. Mostly, they’re the traditional, full-service firms. Online firms get pieces of deals, but not nearly enough to satisfy their soaring numbers of accounts, says Daniel Burke of Gomez Advisors, an e-commerce research firm in Lincoln, Mass. Just 500 customers might get 100 shares each.
To get on the list, you first have to do business with a firm that offers IPOs. At the majors, you also have to have serious money. Merrill Lynch and DLJdirect want at least $100,000 in your account; Fidelity wants $500,000; Charles Schwab wants $1 million. Alternatively, you might make the cut by trading hyperactively–but that takes money, too. Fortunately, Wit Capital lowers the bar to $2,000. At E*Trade, you need only enough to cover the buy.
Even then you’re not guaranteed an IPO winner. Full-service firms, for example, let their top brokers parcel out most of the shares to favored customers.
At the online firms, some general rules govern who gets IPOs. DLJdirect considers how long you’ve been a client and how actively you trade. ETrade reserves a percentage for its beloved heavy traders, but allocates shares randomly. Wit allocates first to customers who bid for the shares on the day the prospectus is released. Often, you get IPOs in 100-share lots, although ETrade is thinking of reducing that amount. Online brokers are making deals left and right with investment banks to get more shares to sell.
What you especially need is access to better IPOs. The stocks that do the best are those still owned by institutions three months after trading starts, says Laura Casares Field, assistant professor of finance at Penn State University. As a general rule, the pros sell (or “flip”) their IPOs within a few hours or days. The poorer issues pass into the public’s hands.
Online brokers, by the way, don’t want you to flip, which they generally define as selling within the first 30 or 60 days. Too much flipping hurts the brokers’ chances of getting more IPOs to sell. If you break their rules, you’ll be off their list. But flipping a winner is the very heart of the dream.
There’s one sure way of owning IPOs: buy one of the small-cap mutual funds that get the shares. Recently, Janus Venture had 25 percent of its money in stocks that went public in 1999. The sizzling First American Technology had 27 percent.
For even more focus, look at the two-year-old, $93 million IPO Plus Aftermarket Fund. It’s run by Renaissance Capital, which specializes in IPO research. The fund rose 18.3 percent in 1998, during a punk year for smaller stocks. In last year’s boom, it soared 115 percent. You get a wild ride, with sudden drops of 28 percent or more. But a fund can recover, while faddish IPOs might not.
Here’s this column’s best tip on individual IPOs: your biggest gains might be made in the aftermarket, where anyone can play. Buying the first pop “isn’t a sustainable way to make money,” First American’s Rollie Whitcomb says. Only 3 percent of his holdings came from original IPO shares. He bought the rest later, in firms with good growth rates, industry position and market prospects.
Opening hype: IPO Plus’s Kathleen Shelton Smith suggests that you check a stock you like one week after the opening hype to see if the price came down. A second price pop might occur after 30 days (that’s when the sponsoring brokers’ lap-dog analysts publish their predictably rosy forecasts).
If the stock still looks too high, check it again in 180 days. That’s the typical “end of lockup date,” when the company’s insiders can sell. Typically, they unload big and the stock price drops. On average, companies that were seeded by venture-capital firms drop triply hard as the VCs bail out, Field says. You’ll find the unlock dates at IPO Plus’s Web site, ipohome.com.
The lucky people who got IPO allocations last year didn’t have to sweat the price. By the end of the year, some 72 percent of those stocks were selling above their offering price. “But a market like this is not likely to be repeated,” Ritter says. Even now, the stocks with the biggest gains are also the most vulnerable. In 1999, 14 smallish companies found themselves worth more than $3 billion after their first trading day. Today, nine are selling below their first-day closing price. One of them, eToys, is lower than its offering price.
IPOs are a short-term game. Over five-year holding periods, they underperform seasoned companies of similar size by 5.1 percent a year, Ritter’s data show. How can you stay on top of the fads that blow in and blow out? In this world, an IPO fund earns its keep.
