Note from Midas Legacy editor: This is a timeless piece from Banker X- please be sure to read this carefully and file this valuable insider insight away…!
As the market moves higher you’re going to see many more Initial Public Offerings (IPOs). After all, it’s a lot easier for companies to sell stock when people are happy and hungry for gains then during a down market.
But, before you pick up your phone and ask your broker to get you stock in the next best thing, you need to understand how the IPO market works from the inside.
Investment banks make money from IPOs regardless of where the share open or what price YOU buy in at. They know ahead of time whether a stock is going to pop or not. They get indications from brokerage firms, institutional clients and other investment banks as to the demand in the market place. This demand is often overstated, but what they are looking for is the level of over subscription.
Subscription refers to an indication of interest in the form of orders from the end buyer. So, if you decide that you want into an IPO, you call your broker and say I want 500 shares. They tally up all of these pre-orders and match them against the number of shares offered. What they are looking for is over subscription by a factor of two to three times or more. So if 5 million shares are offered, they want to see demand for ten million shares. They know at the end of the day that many orders will not come to fruition, so like the airlines, they want to see an oversold condition. After all, they still only have to deliver the shares that are being sold and there is no legal obligation to sell more.
As the orders pour in, the investment bank that is the lead “book runner” can adjust the price upwards or downwards until the night before the IPO is officially priced. You have until that same night to cancel your order as well…assuming that your broker has given you an indication that you will be filled or not. But, before you make that pledge to buy shares look out for the following warning signs.
If you asked for stock in an IPO and your broker doesn’t give you a hard time, run away. If you ask for let’s say 500 shares and your broker says you got them all, then run away. For an IPO to be “hot”, shares must be scarce. If you, as a retail client, can get as many shares as you asked for, that IPO is doomed to fail at the open. That’s what happened with Facebook- Midas Legacy readers were warned off this, but anyone else who bought this IPO could be forgiven for thinking that was a scam.. Nearly everyone who wanted shares at the IPO got them and the results weren’t pretty. That’s because a big chunk of the people who get IPO shares flip them on the first day – they could not care less about the future of the company.
A successful IPO increases its price range in the days before the public offering. This also shows a strong indication of interest. If the company you want lowers the price then you need to run away. Lowering the price means only one thing: there is no demand for the shares and you are going to get screwed. In the days and weeks before the IPO is priced, the company puts on a “road show” to garner interest and explain their operations and future projections. This is meant to build up excitement from institutional clients as well. If these presentations go poorly, the IPO price will decrease or the whole offering may even be scuttled. Look for IPOs that show price increases not decreases prior to the first trading day.
IPOs are a great way to make quick money. But you have to understand that just as many fail to pop as ones that do pop. And, history has shown that almost all IPOs eventually trade back down to their offering price or below. So, if you really wanted the shares of a company but were shut out of the IPO, don’t buy shares at the open or you’ll overpay. Be patient and 90% of the time, you will get the chance to buy the shares at or below the IPO price within a few weeks or months, after the excitement has died down.
To your wealth,
Banker X.
