Bull Vs. Bear: Tech IPOs Are A Smart Play For Savvy Investors

By Stephen D. Simpson, CFA | June 25, 2012 AAA

Question: Is it foolish to buy into tech IPOs?

Bull's Response
Initial public offerings (IPOs), and tech IPOs in particular, seem to garner a disproportionate share of financial media attention. Maybe it's simply the novelty of the new, or maybe it's because hot tech IPOs are often associated with companies that are just coming into their own and getting the attention of the public, but many of these IPOs tend to be real events for the market.

History shows that not all of that attention is well-deserved. The process of bringing a company to the public markets inevitably involves a lot of promotion and hype; bankers profit directly from investor interest in IPOs and almost every company wants to have a hot IPO. In that process, then, it's entirely common for excitement and hope to take the place of reason and prudence, and many of these deals go off at poor prices. What follows is as predictable as Tuesday following Monday - the stocks go out at too high a price and ultimately fade in the after-market, leaving investors who bought into the hype holding losses.

As a result, many commentators and advisors suggest that investors should avoid IPOs. While some IPOs are most certainly to be avoided, there are cases where buying into a tech IPO near its opening date can be a money-making proposition.

SEE: IPO Basics

In a Bad Market, You Can Find Bargains
From time to time, investors will see IPOs where the owners are highly motivated to sell shares and bankers are eager to get a deal done. This is especially true in times where the market has soured on risk and wants nothing to do with speculative stories. In cases like these, bankers may have little choice but to price shares more rationally, and this can offer a chance to buy in near the lows and ride the eventual sector and market rebounds.

You Don't Have to Be Married to Your Positions
IPOs, particularly hot IPOs that have attracted ample media attention, provide a liquid market for traders to work their magic. It is hard for individual investors to get access to IPOs, and that access often comes at the cost of not being allowed to sell those shares quickly. But there's no rule that prevents an investor from buying those shares in the secondary market on the day of the IPO and selling them that very same day or a few days later.

For all of the talk of Facebook's (NYSE:FB) "failed IPO", Facebook has thus far been a pretty big exception for tech IPOs over the last year or so. In fact, most tech IPOs, including names like Jive Software (Nasdaq:JIVE), Pandora (NYSE:P) and Carbonite (Nasdaq:CARB) did quite well indeed in the first week or two after the IPO - and not just for those relatively selective few who got their shares at the IPO price. Yes, all of these stocks did have subsequent pullbacks, but that's why these are appropriate plays only for nimble and risk-tolerant traders.

Good Companies Work out Long-Term
For the truly great companies, the ideal holding period is "forever." Who cares if a stock retreats 10, 20, or even 30% in the weeks following the IPO if the stock later goes on to outsized gains? Does anybody remember (or care) that Google (Nasdaq:GOOG) gave back some ground after its IPO? Ditto for Salesforce.com (NYSE:CRM), VMware (NYSE:VMW) and many other leading tech companies. It's all well and good to recommend that investors just sit tight and buy the shares of a newly public company a few weeks or months after the IPO, but not all IPOs sell off significantly and investors risk out-smarting themselves and seeing the shares run away from them.

The Bottom Line
It often serves an investor very well to wait a bit - from a few weeks to a couple of months - before diving into an IPO. Likewise, investors should be on the lookout for quality IPOs that do fade in the weeks or months after the initial trade.

But just because those statements are true, it doesn't automatically follow that buying an IPO from the get-go is a bad move. Playing hot IPOs, particularly from a day-trading perspective, is absolutely not for everybody, but then that is true of every type of investing and trading. Those investors who believe they can spot the long-term tech champions or the short-term plum trades ought to think seriously about participating in those tech IPOs that might not meet their established criteria for successful positions.

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

Don't forget to read the Bear Side of this debate and weigh in with your opinion below.

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