Initial Public Offerings (IPOs) are the first time a company sells its stock
to the public. Sometimes IPOs are associated with huge first-day gains; other
times, when the market is cold, they flop. It's often difficult for an
individual investor to realize the huge gains, since in most cases only
institutional investors have access to the stock at the offering price. By the
time the general public can trade the stock, most of its first-day gains have
already been made. However, a savvy and informed investor should still watch the
IPO market, because this is the first opportunity to buy these stocks.
Reasons for an IPO
When a privately held corporation needs to raise additional capital, it can
either take on debt or sell partial ownership. If the corporation chooses to
sell ownership to the public, it engages in an IPO. Corporations choose to "go
public" instead of issuing debt securities for several reasons. The most common
reason is that capital raised through an IPO does not have to be repaid, whereas
debt securities such as bonds must be repaid with interest. Despite this
apparent benefit, there are also many drawbacks to an IPO. A large drawback to
going public is that the current owners of the privately held corporation lose a
part of their ownership. Corporations weigh the costs and benefits of an IPO
carefully before performing an IPO.
Performance
The aftermarket performance of an IPO is how the stock price behaves after
the day of its offering on the secondary market (such as the NYSE or the
Nasdaq). Investors can use this information to judge the likelihood that an IPO
in a specific industry or from a specific lead underwriter will perform well in
the days (or months) following its offering. The first-day gains of some IPOs
have made investors all too aware of the money to be had in IPO investing.
Unfortunately, for the small individual investor, realizing those
much-publicized gains is nearly impossible. The crux of the problem is that
individual investors are just too small to get in on the IPO market before the
jump. Those large first-day returns are made over the offering price of the
stock, at which only large, institutional investors can buy in. The system is
one of reciprocal back-scratching, in which the underwriters offer the shares
first to the clients who have brought them the most business recently. By the
time the average investor gets his hands on a hot IPO, it's on the secondary
market, and the stock's price has already shot up.
