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IPO's in the Real World




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This article is from the Investing Articles: Public Offerings: IPO and DPO series.

IPO's in the Real World

Of course knowing the logistics of how IPO's come to market is all fine and dandy, but the real question is, are they a good investment? That does tend to be a tricky issue. On one hand there are the Boston Chickens and Snapples that shoot up 50% or 100%. But then there is the research by people like Tim Loughran and Jay Ritter that shows that the average return on IPO's issued between 1970 and 1990 is a mere 5% annually.

How can the two sides of this issue be so far apart? An easy answer is that for every Microsoft, there are many stocks that end up in bankruptcy. But another answer comes from the fact that all the spectacular stories we hear about the IPO market are usually basing the percentage increase from the POP, and the Loughran and Ritter study uses purchase prices based on the day after the offering hit the market.

For most investors, buying shares of a "hot" IPO at the POP is next to impossible. Starting with the managing underwriter and all the way down to the investor, shares of such attractive new issues are allocated based on preference. Most brokers reserve whatever limited allocation they receive for only their best customers. In fact, the old joke about IPO's is that if you get the number of shares you ask for, give them back, because it means nobody else wants it.

While the deck may seem stacked against the average investor. For an active trader things may not be as bad as they appear. The Loughram and Ritter study assumed that the IPO was never sold. The study does not take into account an investor who bought an issue like 3DO (THDO - NASDAQ), the day after the IPO and sold it in the low to mid 40's, before it came crashing down. Obviously opportunities exist, however it's not the easy money so often associated with the IPO market.

 

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