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Your take: Is investing in IPOs smart, or strictly for muppets?

Posted By Claes Bell On 11/08/2013 @ 8:30 am In Your Take | 5 Comments

Lots of people lined up yesterday to buy shares of brand-spanking new Twitter stock. Initially priced at $26 a share, Twitter stock was going for $45.10 when trading began, and at one point was up near $50.

Big pops like this are pretty common with high-profile IPOs (short for initial public offering); many rank-and-file investors can’t wait to get in on the new hotness and quickly drive the price up, buying in at price points so high they’ll probably never make much money on the stock.

Yes, there’s a reason why regular Joes who try to get rich quick by investing in IPOs are derisively called “muppets” by seasoned traders: they are often just dupes doing their part to enrich people who got in on the ground floor of the IPO, and typically lose money in the process.

The sad truth is that most of the people that make big money on IPOs, besides the company’s founders and the venture capital investors who backed them initially, are the big investors who are issued shares directly at the IPO price. Hot IPOs are usually oversubscribed, which means there are more people who want buy more shares of the IPO than there are shares available. When that happens, the investment bank handling the IPO gets to pick and choose who gets ahold of those hard-to-get shares, and they tend to pick big clients who will reward them in the form of lots of future business.

By the time the stock closed yesterday at $44.90, investors who got Twitter shares at $26 had already made a 72 percent return, but all the people that got in when trading first started at $45.10 had already lost money.

Only time will tell how Twitter does over the long haul, but IPOs don’t have a great track record of making money for investors. Ignoring that first-day pop that benefits mostly ground-floor investors, from 1970 to 2009, IPOs have underperformed stocks of similarly-sized companies by 3.4 percent over the first five years of issuance, according to a 2009 study by Jay Ritter of the University of Florida.

I rarely buy individual stocks, but even when I do, I usually avoid IPOs. Sure, I’ve probably missed out on some big gains as a result, but at least I’ve never had to look in the mirror at the end of the first day of trading and see a muppet who’s lost money.

So what I’m interested in hearing your take: are IPOs a good investment opportunity, or a chance for big investors to benefit at the expense of hapless muppets?

Here’s something to listen to while you decide:

(Photo: Matt Trostle)


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