IPO's

Initial public offerings can offer substantial opportunities to investors since they can supposedly get in on the ground floor. But a recent study by two acamedicians studying new offerings over the last 20 years suggest that brokerage firms are wrong in making such statements. Most IPO's are overpriced and that the problem is worst when the market is hot. The study showed that buying at the closing price of the first day provided only about a 2% annual return- about 1/7 of the average profit from similar public companies. The study further suggested that the companies were timing their offerings to coincide when the industries were at peak prices. And they often go public just before the company's growth pattern begins to slow- disappointing investors who expected continued growth.

Initial Public Offerings are the most profitable underwritings and generate substantial fees. On a typical IPO, the underwriting fee is 7%. The two or three managing underwriters usually split 80% of this fee with the rest going to the dozen or so brokerage firms that help sell the stock. The underwriters net profit- after paying attorneys and internal staff- is around 33% to 40%. Commission trading on the other hand produces only about $.06 per share. But it is very profitable in a bull market- very poor in a bear market.

Here are some definitions you should never need. Why? Because buying IPO's are sucker bets even for some institutions.

AFTERMARKET: The period after the stock has been sold to the public when selling by insiders and institutions has picked up and more shares are available for small buyers

BAKEOFF: When investment banking firms compete in meetings for corporate business.

BOOSTER SHOT: When a underwriter, in the wake of a public offering, issues its first formal report recommending purchase of a client's stock

FLIP: When investors sell a stock soon after offering- brokers and companies don't like this and try to get you to stay in.

FRIENDLY HANDS: When IPO stock is owned by people likely to hold onto it.

FULLY SUBSCRIBED: When underwriters have takers for all the IPO stock on offer.

LOCKUP: The period, generally for four months after the public offering, during which the corporate officers, directors and other insiders cannot sell stock issued before the offering

UNDERWRITER: Investment banker who, alone or as a member of a group, agrees to purchase a new issue of stock and distribute it to investors

OVERSUBSCRIBED: When a deal is so hot that the underwriter will, in all likelihood, sell extra stock

FUNNING THE BOOK: A term used to described the lead managers duties as boss of the underwritings syndicate.

IPO'S: A 1992 study by David L. Babson & Co. showed that IPO's are bad investments. They looked at 452 IPO's that year and

1. 69% were afflicted by declining sales and earnings trends while only 14% showed improvement

2. Almost 80% achieved peak profit margins within four quarters before or after their offerings. SIXTY percent then slipped in profitability within two years of their IPO.

3. A quarterly earnings drop in the first four quarters after the IPO occurred in 58% of the companies. More than 75% had a decline within two years.

4. 1/3 of the companies had a sales decline within four quarters and 45% had a sales drop within two years.

5. 19% actually lost money in one of the first four quarters after the IPO.

6. 25% lost money throughout the two year period of the study.

In fairness, the winners enjoyed an average price increase of 134% from their IPO dates and 71% from the close of their first trading date. 76% outperformed the overall market from their IPO date and 72% outperformed from the first day's close. Admittedly, the last part shows significant promise- that is till you realize that most of the better IPO's are already pre sold to institutional investors. You'll probably only get the dregs. Better to use a small cap firm that specializes.

IPO'S: 1996 "Seven out of ten IPO's underperform the market in the two years after they start trading" per professors at Cornell and Dartmouth. And if a brokerage firm underwrote the issue, these IPO's did 55% WORSE than those IPO's recommended by non underwriting firms. It is true that recent IPO's have done well. In fact, the average 1995 IPO rose 20.5% from their offering price on the first day and more of those IPO's doubled on the first day than in the previous 20 years combined. But you'll never get one since, if it is expected to go up, the heavy hitting institutions already got a lock on buying all of it.

IPO'S: 1998 (WSJ) A University of California Associate Professor said "I believe that most firms manipulate earnings. Around an equity offering, it becomes economically meaningful because of the economic benefits. Another Associate Professor said, "my advice for anyone who is not an expert in the area: don't invest in IPO's."

The problem is due to a "legal" accounting system that allows companies to beef up apparent earnings at the time of the offering. They do that by recognizing revenue as swiftly as possible or by delaying expenses, or both. Again, if you do not know diversification by the numbers, you don't have the foggiest idea of the intricacies of individual stocks. And certainly not for investing in IPO's.

IPO'S: (WSJ 1998) A University of California Associate Professor said "I believe that most firms manipulate earnings. Around an equity offering, it becomes economically meaningful because of the economic benefits. Another Associate Professor said, "my advice for anyone who is not an expert in the area: don't invest in IPO's."

The problem is due to a "legal" accounting system that allows companies to beef up apparent earnings at the time of the offering. They do that by recognizing revenue as swiftly as possible or by delaying expenses, or both. Again, if you do not know diversification by the numbers, you don't have the foggiest idea of the intricacies of individual stocks. And certainly not for investing in IPO's.

IPO's: (1999) Some investors think these are sure winners. But here are some more recent statistics from a recent Business Week. At the initial offering, the prices may come up- but they tend to almost universally drop immediately thereafter and are therefore primarily for traders. An experienced trader said that "the prices of IPO's are so inflated that it is not worth keeping them overnight." In a review of over 3,100 IPO's over the last 4 years, it showed that "earnings of 60% disappointed investors by the third quarter....." And, "for every Microsoft, there are five other stocks that disappear from the face of the earth".

So before your ego tempts you to go out and spend too much money in a high flyer, do your homework. They you probably won't buy at all.

IPO's: (2000 CommScan) The average IPO of 1997 earned just 1.8% by the end of a year. During 1990- 1998, the average return was 8%. Another study at the University of Florida noted that from 1970- 1993 an IPO earned 7.3% average return. That was 5.6% less that the stocks of similar companies.

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