New York - Most initial public stock offerings ("IPOs") are high risk. Initially, the amount of stock available for purchase is generally limited and, if it is a high-profile IPO, you will not be able to purchase an initial substantial amount. Most investors, including institutional investors buy stock in what is referred to as the "aftermarket."
IPOs should generally be evaluated by comparing the stock of the new company to publicly traded competitors. For example, a food company's valuation would be compared to other food companies that are publicly traded. An underwriter would decide what attributes the new company has or does not have as compared to the existing competitor. Underwriters then determine an expected growth rate and discount the risk and prices the stock accordingly. This same approach should be used by individual investors.
You should also consider the background and incentives of the people involved. Is management selling all their shares or are they retaining a significant portion? Are the underwriters and accountants associated with the prospectus - blue chip and well established or are they from firms you never heard of. All these factors are important.
A decision to buy an IPO should be based on your willingness to assume the risk that future growth or future management plans will not occur and if you believe the underwriter has undervalued the potential of the company. Consider the special factors affecting the below type of IPOs:
- Technology Stocks - Most technology stocks are based on possibility of future sales and profits based on a cutting-edge technology. Current sales are none or slim and management is less experienced. If you do not know the technology, we recommend not investing in the stock.
- Mutual Savings Banks - Mutual savings banks are owned by their depositors. For the past 5 years, most mutual savings banks have tapped into the public market to obtain more capital and become publicly traded. Depositors have the first opportunity to buy the shares prior to the commencement of public trading. If you are a depositor, you should receive a prospectus from the bank indicating how much stock you are eligible to buy.
- Biotechnology Stocks - Will the company have sufficient cash to cover its burn rate or the amount of cash necessary to cover operating expenses or will it need to raise additional funds in the future? The FDA requires drugs to go through an extensive approval process. If the product is in its early stages of development, the Company may have to spend significant amounts of cash on testing and additional investments. Every biotechnology company should have a major blue-chip investor (e.g., Merck) or stay away.
We generally believe that a wait and see strategy will provide the best risk-reward potential. Most individuals have an overwhelming urgency to buy-in early. This usually sends the stock price up quickly. Speculation is usually the worst possible strategy. Generally, it is better to wait four to six months, or even a year, to see how these young companies perform and handle the pressures of being a public company. Some companies go public prematurely and initially the stock goes down for several years. However, as time goes by and products are proven, the company obtains respect from Wall Street and like fine wine - they get better with age.
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