IPO Basics: Don't Just Jump In
  1. IPO Basics: Introduction
  2. IPO Basics: What Is An IPO?
  3. IPO Basics: Getting In On An IPO
  4. IPO Basics: Don't Just Jump In
  5. IPO Basics: Tracking Stocks
  6. IPO Basics: Conclusion

IPO Basics: Don't Just Jump In


Let's say you do get in on an IPO. Here are a few things to look out for.

No History
It's hard enough to analyze the stock of an established company. An IPO company is even trickier to analyze since there won't be a lot of historical information. Your main source of data is the red herring, so make sure you examine this document carefully. Look for the usual information, but also pay special attention to the management team and how they plan to use the funds generated from the IPO.

And what about the underwriters? Successful IPOs are typically supported by bigger brokerages that have the ability to promote a new issue well. Be more wary of smaller investment banks because they may be willing to underwrite any company.

The Lock-Up Period
If you look at the charts following many IPOs, you'll notice that after a few months the stock takes a steep downturn. This is often because of the lock-up period.

When a company goes public, the underwriters make company officials and employees sign a lock-up agreement. Lock-up agreements are legally binding contracts between the underwriters and insiders of the company, prohibiting them from selling any shares of stock for a specified period of time. The period can range anywhere from three to 24 months. Ninety days is the minimum period stated under Rule 144 (SEC law) but the lock-up specified by the underwriters can last much longer. The problem is, when lockups expire all the insiders are permitted to sell their stock. The result is a rush of people trying to sell their stock to realize their profit. This excess supply can put severe downward pressure on the stock price.



Flipping
Flipping is reselling a hot IPO stock in the first few days to earn a quick profit. This isn't easy to do, and you'll be strongly discouraged by your brokerage. The reason behind this is that companies want long-term investors who hold their stock, not traders. There are no laws that prevent flipping, but your broker may blacklist you from future offerings - or just smile less when you shake hands.

Of course, institutional investors flip stocks all the time and make big money. The double standard exists and there is nothing we can do about it because they have the buying power. Because of flipping, it's a good rule not to buy shares of an IPO if you don't get in on the initial offering. Many IPOs that have big gains on the first day will come back to earth as the institutions take their profits.

Avoid the Hype
It's important to understand that underwriters are salesmen. The whole underwriting process is intentionally hyped up to get as much attention as possible. Since IPOs only happen once for each company, they are often presented as "once in a lifetime" opportunities. Of course, some IPOs soar high and keep soaring. But many end up selling below their offering prices within the year. Don't buy a stock only because it's an IPO - do it because it's a good investment.

IPO Basics: Tracking Stocks

  1. IPO Basics: Introduction
  2. IPO Basics: What Is An IPO?
  3. IPO Basics: Getting In On An IPO
  4. IPO Basics: Don't Just Jump In
  5. IPO Basics: Tracking Stocks
  6. IPO Basics: Conclusion
RELATED TERMS
  1. Lock-Up Agreement

    A legally binding contract between the underwriters and insiders ...
  2. Initial Public Offering - IPO

    The first sale of stock by a private company to the public. IPOs ...
  3. IPO Lock-Up

    A contractual caveat referring to a period of time after a company ...
  4. Lock-Up Period

    Window of time in which investors of a hedge fund or other closely-held ...
  5. Laddering

    The promotion of inflated pre-IPO prices for the sake of obtaining ...
  6. Stabilizing Bid

    A practice used by underwriters to stabilize the secondary market ...
RELATED FAQS
  1. What is an IPO lock-up period and how long is it?

    An initial public offering (IPO) lock-up period is a contractual restriction that prevents insiders who are holding a company's ... Read Answer >>
  2. What does the underwriter do in a new stock offering?

    Learn the role an underwriter plays for an initial public offering, and the steps an underwriter takes in preparing for an ... Read Answer >>
  3. Are IPOs available to short sell immediately upon trading, or is there a time limit ...

    The quick answer to this question is that an IPO can be shorted upon initial trading, but it is not an easy thing to do at ... Read Answer >>
  4. Who can get access to a highly anticipated IPO?

    Purchasing a highly anticipated initial public offering may seem like a sound investment strategy, but most individual investors ... Read Answer >>
  5. How can average investors get involved in an IPO?

    An initial public offering, or IPO, is the first sale of stock by a new company, usually a private company trying to go public. ... Read Answer >>
  6. Do underwriters make guarantees to sell an entire IPO issue?

    Underwriters represent the group of representatives from an investment bank whose main responsibility is to complete the ... Read Answer >>

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