Someone asked me recently if I thought they should by the upcoming Twitter initial public offering (IPO) or not.
Some IPOs take off and hold above their IPO price (the price at which they go public) and some fall far short of the IPO price.
IPOs are very speculative and some are outright gambles, just to be blunt about it. Why?
For starters, there isn't enough data that's publicly available on these companies to make an educated decision about them. You don't have years of earnings reports at your disposal like you have with most publicly traded companies.
Instead, people are buying them largely based off of hype and emotion and the chance to "get richer quicker." However the IPO road is littered with landmines.
For instance, the most talked-about IPO that I can remember was the Facebook IPO. People bought it because "everyone knew about it" and they had around a billion users.
The problem? It's practically the job of the underwriter to overprice a security going public. The underwriter wants to get the most out of it that they can for themselves and for the company. So the chance of buying the stock at an overvalued price right out of the gate is huge.
What did Facebook do? It began trading around $38 and dropped like a stone for months until it finally bottomed in the $18s or $19s. In case you're keeping score, that's a 50 percent drop within mere months. It was way overhyped and therefore the underwriters practically had a "license" to overprice the stock and actually get the price they were looking for.
Why? Overly-emotional people tend to be irrational people. Get someone hyped up and they'll overpay much of the time. Auctions are famous for this, as an example.
LinkedIn was another overhyped IPO. It was priced high. It dropped after its IPO price and didn't really hold above its IPO price until about a year later.
The moral of the story here is that the "smart money" overvalues the stock typically from the very beginning and then sells it off to the "dumb money." I once had a person say, "If you don't know who the sucker is in the room, then it's you!" So don't be the sucker.
Is it possible for an IPO to price and head higher and never look back? Sure! But IPOs are such huge speculations. And the truth be told, most people put far too much of their net worth into them. It's the greed factor that compels them to do stupid things. But if you're going to be successful in life, you're going to have to learn to control both greed and fear and make decisions with neither of them being materially involved.
So if you're interested in a "hot stock" that is going public, it generally pays to sit on your hands and wait some months for a much lower price and cheaper valuation relative to its earnings than what the people who bought it at the IPO phase did.
The people that make the biggest amount of money aren't even the people who buy the IPO anyway. They are the people who owned shares when it was a private company. Private equity firms and very rich people tend to have access at this phase. These are the people who take the initial huge risks, but if it pays off and the company goes public, they are the ones making a killing.
So don't get worked up about the Twitter IPO or any other IPO. Besides, you have to ask yourself, "Why am I really buying this IPO anyway?"
You most likely wouldn't be buying it because of its cheap fundamental valuation. And you probably wouldn't be buying it because of its earnings, because most people don't even know what they earn or don't earn. You sure wouldn't be buying it due to the technicals on the chart since it has no previous history.
So what good reason is there that you'd be buying it? Answer that question first before buying the Twitter IPO or any other IPO for that matter.
I think what you'll find is that if you look at the multiyear charts of many IPOs, you'll find that if you had patience you could buy them months or a year later for far less than the IPO price is. And by that time, you'd have public reports that you could look at to see what their earnings are and how much their assets are actually worth, how much cash they have on their books, etc. So you'd make a far more educated decision and you'd likely be buying it at a cheaper price than the IPO price too. That seems like more of a reasonable way to buy a newer publicly traded stock.
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.
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