There are approximately 2,800 listings that trade on the New York Stock Exchange (NYSE), and a comparable number that trade down the street on Nasdaq. These companies range from the leviathan (Apple, worth a collective half a trillion dollars), to the inconsequential (each with a market capitalization of less than the price of a car). Every last one of those companies had to start somewhere. They each sprang to trading life as initial public offerings (IPOs), originally going on sale to ravenous investors and speculators looking for quick, if not instant, profits.

SEE: Top IPO Nations

How an IPO Works
IPO is one of the few market acronyms that almost everyone is familiar with. The term conjures up pictures of sudden millionaires watching in glee as their previously inert holdings are translated into actionable money. If you've taken even a cursory look at the business news over the past few months, you're probably aware that Facebook is moments away from its initial public offering. Today, you can't buy Facebook stock because there's no publicly available stock to buy. One morning, however, that will change; the trading floor will open, Facebook's symbol will scroll across the ticker and its stock will be available to whomever wants it - kind of.

Before an IPO, a company is privately owned - usually by its founders and maybe the family members who lent them money to get up and running. In some cases, a few long-time employees might have some equity in the company, assuming it hasn't been around for decades. The founders give the lenders and employees a piece of the action in lieu of cash. Why? Because the founders know that if the company falters, giving away part of the company won't cost them anything. If the company succeeds, and eventually goes public, theoretically everyone should win: a stock that was worth nothing the day before the IPO will now be worth some positive number of dollars.

However, because their shares don't trade on an open market, those private owners' stakes in the company are hard to value. Take an established company like IBM; anyone who owns a share knows exactly what it's worth with a quick look at the financial pages. A privately held company's value is largely a guess, dependent on its income, assets, revenue, growth, etc. While those are certainly much of the same criteria that go into valuing a public company, a soon-to-be-IPOed company doesn't have any feedback in the form of a buyer willing to immediately purchase its shares at a particular price.

Anonymity Vs. Fame
The vast majority of those roughly 5,600-odd NYSE and Nasdaq listed companies have been trading in glorious anonymity from day one. Few people care what Cardinal Health or Trinity Industries do on a regular basis, or even know they exist, and management prefers it that way. (Just ask publicly traded British Petroleum (BP) whether no news is good news.)

When most companies offer shares to the public, initially the news barely registers with anyone outside of the securities industry; however, when a highly publicized Facebook, Yelp or Groupon walks onto the dance floor, lay people take notice. That's because such companies operate on the retail level, or its equivalent. They're ubiquitous. There aren't hundreds of millions of people logging into their Cisco account to post photos multiple times a day, and no one's going to make a Hollywood feature film about the brash young Ivy Leaguers with big dreams who founded American Railcar Industries.

Can You, and Should You, Buy?
So why doesn't every investor, regardless of expertise, buy IPOs the moment they become available? There are several reasons:

The first reason is one based on practicality, as IPOs aren't that easy to buy. Most people don't have brokerage accounts, it takes time and money to open one, and even if you make it that far, placing a "buy newly issued stock X" order is harder than it sounds. The company that's about to go public sells its shares via an underwriter - a giant investment bank tasked with the process of getting those shares into investors' hands. The underwriters give first crack to institutions - i.e., if you're a Morgan Stanley account holder, Morgan Stanley brass is going to keep its allotment of a finite IPO and offer the rest to its favorite (i.e., largest) clients, before deigning to let you on board.

Almost every stock's price falls from its IPO level for reasons that will be clear in a few seconds. When a stock goes public, the company insiders who owned the stock in the first place are legally prohibited from selling it for a fixed period - set by Securities and Exchange Commission (SEC) regulations - of at least three months. Up until that point, the insiders are rich only on paper. The moment they can sell, they usually do - all at once. This, of course, depresses the stock price. It's at that point, with a glut of shares entering the market, that ordinary investors often get their first crack at what is now an IPO well along in its infancy.

The Bottom Line
The late and legendary Benjamin Graham, who was Warren Buffett's investing mentor, decried IPOs as being for neither the faint of heart nor the inexperienced. They're for seasoned investors; the kind who invest for the long haul, aren't swayed by fawning news stories, care more about a stock's fundamentals than its public image, like companies that have something of a definable history, stay objective, have established bankrolls, and aren't in the habit of buying stocks that have downward pressure applied on them out of the gate. If that doesn't describe you - and let's be honest here, it doesn't - do yourself a favor: Like piloting jetliners and removing gallbladders, leave the job of investing in IPOs to the professionals.

SEE: The Biggest IPO Flops

Related Articles
  1. Stock Analysis

    If You Had Invested Right After Costco's IPO

    Find out how much your investment would be worth if you had invested $1,000 during Costco's IPO and how much you would have received in dividends.
  2. Stock Analysis

    If You Had Invested Right After Kraft's IPO

    Discover the complicated history of the Kraft Heinz Company and how much an investment in its initial public offering in 2001 would be worth today.
  3. Active Trading

    FYI On ROI: A Guide To Calculating Return On Investment

    Return on investment is a simple equation that can give you an edge when fine-tuning your portfolio - here's how to use it.
  4. Forex Education

    Understanding The Income Statement

    Learn how to use revenue and expenses, among other factors, to break down and analyze a company.
  5. Stock Analysis

    If You Had Invested Right After Coca-Cola's IPO

    Discover how one $40 share, with dividend reinvestment, over 90 years ago in the Coca-Cola Company would have made you a multimillionaire today.
  6. Stock Analysis

    If You Had Invested Right After Cisco's IPO

    Discover how Cisco became one of the greatest IPOs in history during the 1990s and how it continues to innovate and move forward today.
  7. Stock Analysis

    If You Had Invested Right After Amgen's IPO

    Discover how $1,000 invested in Amgen during its initial public offering (IPO), without reinvesting dividends, would be worth over $427,000 as of November 2015.
  8. Professionals

    The Best Financial Modeling Courses for Investment Bankers

    Obtain information, both general and comparative, about the best available financial modeling courses for individuals pursuing a career in investment banking.
  9. Chart Advisor

    Now Could Be The Time To Buy IPOs

    There has been lots of hype around the IPO market lately. We'll take a look at whether now is the time to buy.
  10. Active Trading

    10 Steps To Building A Winning Trading Plan

    It's impossible to avoid disaster without trading rules - make sure you know how to devise them for yourself.
  1. When did Facebook go public?

    Facebook, Inc. (NASDAQ: FB) went public with its initial public offering (IPO) on May 18, 2012. With a peak market capitalization ... Read Full Answer >>
  2. Can mutual funds invest in IPOs?

    Mutual funds can invest in initial public offerings (IPOS). However, most mutual funds have bylaws that prevent them from ... Read Full Answer >>
  3. What is a stock split? Why do stocks split?

    All publicly-traded companies have a set number of shares that are outstanding on the stock market. A stock split is a decision ... Read Full Answer >>
  4. How do I place an order to buy or sell shares?

    It is easy to get started buying and selling stocks, especially with the advancements in online trading since the turn of ... Read Full Answer >>
  5. Is there a difference between financial spread betting and arbitrage?

    Financial spread betting is a type of speculation that involves a highly leveraged derivative product, whereas arbitrage ... Read Full Answer >>
  6. What does a high turnover ratio signify for an investment fund?

    If an investment fund has a high turnover ratio, it indicates it replaces most or all of its holdings over a one-year period. ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Bar Chart

    A style of chart used by some technical analysts, on which, as illustrated below, the top of the vertical line indicates ...
  2. Bullish Engulfing Pattern

    A chart pattern that forms when a small black candlestick is followed by a large white candlestick that completely eclipses ...
  3. Cyber Monday

    An expression used in online retailing to describe the Monday following U.S. Thanksgiving weekend. Cyber Monday is generally ...
  4. Take A Bath

    A slang term referring to the situation of an investor who has experienced a large loss from an investment or speculative ...
  5. Black Friday

    1. A day of stock market catastrophe. Originally, September 24, 1869, was deemed Black Friday. The crash was sparked by gold ...
Trading Center