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Is it still profitable for average investors to get into the IPO of a stock?

October 31, 2016

In this article we analyze if it’s still profitable for average investors like you and I to invest in the upcoming IPOs.


One thing we know for sure and can agree on, gone forever the day where someone can buy something like few dollars/share, and in a few years or even shorter, the stock turns into hundreds dollars/share.  


The culprit of end of this phenomenon is the active private investor group.  Nowadays a company stays private for as long as they want since there’s simply not a shortage of cash in the private investor money pool.  With all the angel investors around, they are willing to take manageable risks to invest in companies that might not be profitable today and hope it can be another Microsoft (MSFT), Apple (AAPL), Amazon (AMZN), Netflix (NFLX), Priceline(PCLN), etc.  


Nowadays, company usually gets to a considerable size before they consider to list it as a public company.  By that time, the company is fairly established and sizeable revenue.  Then the company finds an underwriter to take their company public.  The underwriters are just big investment banks such as Citi Group, Goldman Sachs, JP Morgan that acts as the middleman/salesman between the company and the average investors.  They have the connections to advertize the company to be listed in IPO market and gauge the interest in the stock.  Then the underwriter will price the initial IPO price by gauging the interest and looking at the financial statements from the company.  


The company decides how much shares/percentage of the company they want to be listed in the IPO sale. Then the underwriter file all the paperwork with the wall street and after all is said and done, a date is set for the company to be IPO.  There are three main stock exchanges in United States for a company to sale their shares: New York Stock Exchange (NYSE), NASDAQ, and Chicago Stock Exchange (CHX).  NYSE is the more prestigious out of the three and usually has higher/stringent requirement for companies to be listed on its exchange.  Some stocks even listed in what’s known as Over The Counter (OTC) markets.  The OTC market has almost minimum requirement for listing and financial statements.  Even though Microsoft (MSFT) started as a OTC stock, but that was over 30 years ago, remember today is different, you as an average investor should stay away from OTC stock if you can, unless you have money to burn or gamble.  


The first day the stock become available to the public, that means the public can finally buy shares of the company.  The risks usually outweighs the benefits when investing in IPO nowadays.  There are few main reasons:

  • The company’s previous financial statements might not be accurate due to no need for external auditors.  After it becomes a public company, external auditors are required to examine and verify its financial statements and CEO will be liable for the validity of the numbers the company report to the investors

  • There are not great deal of information on the company such as its track record, its competitors, risks, and so forth.  

  • The price might be temporarily propped up by the underwriters and their friends.  Since there’s a direct benefit to the underwriter the stock does well on the IPO day, the underwriter will try their hardest to get the stock most attention in the media.  


There’s usually a lock up period of between 90 and 180 days to prevent insiders such as company’s management and early investors to sell their holding of the shares of the company.  


We here at Teenanalyst usually do not recommend average investors to invest in IPOs.  There are more risks than benefit.  However, you can still find diamond in the rough in you look hard enough and willing to take the risks.  If you choose to do so, make sure you do all the homework you can on the company before you make you decision.  Happy Investing.  


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