The IPO craze is in full bloom and you’re the sucker waiting to be fleeced by the Wall Street advertising machine. It’s beyond me how people constantly get suckered into all manner of Initial Public Offerings (IPOs) based on the numbers that are put out by the very sellers of those dreams.
You hear about the first day gains or the gains made by IPO investors. But that’s the minority – a very small number. The real number that you should be focused on is the gain after the first trade since that is likely closer to the number that you’ll be paying.
For example, people are touting how Twitter (TWTR) has more than doubled form its $26 IPO price. Yes, it’s more than doubled from its issue price, but unless you got in before the deal traded, your gains have to calculated from the price it traded at on the first day. Based on that number, you’re up, but only around 30% – a great gain, but a far cry from “over 100%”.
The underwriters on Wall Street, the big banks and investment houses, know exactly where a stock is going to trade when it opens. They have standing orders to either buy more shares or sell shares and they dictate the trading. In order for an IPO to be successful on the first day, it needs to meet certain criteria.
First, it needs to be over-subscribed. Before an IPO is priced, the underwriting firms receive orders that indicate interest. These orders are sent in from institutions, large investment banks, hedge funds, Sovereign Wealth Funds, major individual investors, friends and family and lastly individual retail investors. You can guess where you are on that chain.
That’s right, as an individual retail investor, you are dead last to receive an allocation for an IPO and believe me, it you do receive an allocation that you wanted, you are going to lose money. Wall Street keeps free money for itself.
The underwriters then tally the orders and measure the interest based on the shares available. They are not looking for one share of demand for each share of supply. That would be a disaster since it would indicate poor demand. They know that a certain percentage of buyers will fall off at the last moment since the buyers may place multiple indications of interest through various brokerage firms. What they are looking at for a successful IPO is five or more “buy” orders for every share for sale. This indicates to them that not only is demand firm going into the IPO but there will also be buying coming in after the IPO. After all, they need someone to “flip” the shares to.
The most successful IPOs share some common characteristics. First there is little to no selling by insiders and the monies raised go directly to the company. Second, there are a limited number of shares available for sale, usually less than 15% of the shares outstanding. And, third, the over subscription rate should be between 10 and 25 times. Yes, there are IPOs that have come out with 25 times the number of shares looking to be bought than sold. Those are the ones you want to sell your offspring to get into, so to say.
IPOs can make you money, a lot of money. But, you need an “in” to enjoy the gains advertised by Wall Street banks. Otherwise, you are commonly referred to as the “outside buyer” and there is a simple adage you should keep in mind, always: “if you’re not on the inside, you’re on the outside”!
To your wealth,
Banker X.
