Fox Business Network recently (FBN) called to have me come on The Willis Report and give my thoughts about the upcoming Alibaba initial public offering (IPO). I thought I’d share those insights with you and even expand upon them.

People love IPOs. It appeals to the greed factor within man. They love the thought of quick profits. They also love the thought of buying something “new” or “cutting edge,” etc.

That’s why they love buying the LinkedIns, Facebooks and Twitters of the world. However, if you follow IPOs, they don’t usually work out the way people think. Yet it still doesn’t keep people from stumbling over themselves trying to buy them just as soon as the stock starts trading publicly. Even though, this is one of the dumbest things they could do.

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Why? Well, for instance, in the “hot IPOs” mentioned above, they all fell around 50 percent within months of going public.

Next, there is huge uncertainty when a stock goes public because people are antsy about it.

They don’t know if it’s “going to the moon” or if it will be dumped hard. So this causes tons of volatility, sometimes pricing errors, etc. (like Facebook had), etc.

So if you want to step into a field full of landmines, buy an IPO right after it goes public.

Another huge reason why you don’t want to buy Alibaba or any other IPO when it goes public is because it’s practically the job of the IPO underwriter to overprice the stock. Why?

It gets the company “top dollar” as they rake in the most cash possible and it reaps the underwriters the highest fees possible. So on that end, everyone is happy.

However, the other side of the coin is the buyer of these stocks after they IPO. The buyer (the retail investor) is overpaying, and unfortunately they’re glad to do it. Why? They’re hyped up about the new stock that they think they’re about to get rich off of (and the media helps build the hype and that just adds fuel to the fire.)

You see, the key to buying stocks successfully is to buy them when they are undervalued, not even fairly valued. Yet when buying an IPO, if you’re lucky they are fairly valued but experience has taught me that it’s the easiest time in the world to overprice a stock…and so that’s what the underwriters do. The hype is at its greatest and the sentiment is uberpositive at that moment. And these underwriters aren’t stupid. So they capitalize on it by overpricing the stock.

Meanwhile, the retail investor is typically the one that gets stuck “holding the bag” because they typically have no idea how to properly value a stock (nor are they interested in being rational and properly evaluating it either). In fact, they’re not thinking about valuations at all.

They’re thinking about “the dream” they have of buying the stock and it going to the moon to where they can kiss their jobs good-bye and retire early.

Many people make huge gambles during these times by putting lots of their investable income into these IPOs. Then they get ticked when they drop by 50 percent and want to go scream to a regulator that they didn’t know what they were doing. Yet, had they of “made off like a bandit” as the stock went to the moon, they wouldn’t have a complaint at all.

But I’m encouraging you to avoid ALL of these pitfalls mentioned above by simply avoiding these IPOs altogether until they minimally have enormous drops in their stock prices. (And you’d be surprised that many of the companies are still technically overvalued even then). But if you’re going to speculate on an IPO, the wisest way to do it is to sit on your hands until the stock price takes a huge hit.

This requires lots of patience because it could take months for the stock to have a huge drop like I’m talking about. But if you want to wring out a lot of the froth that’s in the stock’s price due to the underwriter overpricing the stock, then this is what you do. You wait for the stock price to take a huge percentage hit from the price at which it begins publicly trading (like a 35 percent to 50 percent hit) before snatching up the stock. And even then, make sure you’re investing only a small percentage of your overall portfolio.

Remember, many stocks that IPO don’t ultimately make it. Many, many of them end up failing over time. Think about how many tech stocks launched an IPO and how many of those are around today. Also, think about how many internet stocks had an IPO and how many of them are around today. Also, think about the wild rollercoaster rides that their stock prices have had since the IPO and in the months to years that followed.

So know what you’re signing up for when or if you get involved with a stock that has recently launched an IPO. Then if it doesn’t go as you thought, don’t complain. These are speculations — high-risk investments.

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I’m not sugar-coating it because I want you to know what you’re getting into when you play that game. Don’t do it if you don’t have the stomach for it and don’t do it with capital that you can’t afford to lose.

If it’s money that you need for your retirement, it shouldn’t be in an IPO in the first place.

So take all of these things into account before getting involved with IPOs, no matter how sexy they appear to be — including Alibaba!

About the Author: Sean Hyman
Sean Hyman is a member of the Moneynews Financial Brain Trust. Click Here to read more of his articles. He is also the editor of Ultimate Wealth Report. Discover more by Clicking Here Now.