Don't Fall Into the IPO Trap

 | May 13, 2014 | 12:30 PM EDT  | Comments
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Stock quotes in this article:

twtr

,

FB

So far, this year has been great for IPO investors. That's what the headlines say. But as usual, there is more substance beneath the headlines. Investors should take heed the next time they get excited about an upcoming initial public offering.

IPOs have been great for some investors but not all investors. And odds are that you have ended up on the losing side of the IPO trade. According to data from IPOScoop.com, the inside investors spin gold from IPOs, and individual investors are usually left holding the bag.

When Twitter (TWTR) went public, the IPO price was set at $26. Insiders and other investors who bought shares at the IPO price are up more than 20% on the investment. However, the majority of investors bought in at the first-day closing price, and those investors are down nearly 30%.

The restaurant chain Noodles (NOOD), which went public to great fanfare that it could do for Asian cuisine what Chipotle Mexican Grill (CMG) did for Mexican food, has been tasty for IPO investors but a limp noodle for those who bought shares on trading day. IPO investors are up more than 70%, while those who bought on day one are down 14%, on the basis of the IPO price of $18 and first-day closing price of $36.75.

In fact, according to IPOScoop, the 242 IPOs that have come to market in the past 12 months have treated the two classes of investors similarly. Investors who got in at the offering price are up 12% on average over the past 12 months. But investors who bought on at the trading price, the great majority, are down 3%.

The key takeaway here is patience, and patience cuts both ways. First, most investors should make it a policy to avoid IPOs, especially during the initial days of trading. On the other hand, if you are going to buy in after the IPO because you fundamentally believe that the company in question remains an attractive investment, be prepared to exercise patience. Facebook's (FB) stock is up by more than 50% from its IPO price, and it was months before it traded above the first-day trading price. Others such as Groupon (GRPN) are underwater for all investors.

An IPO is designed to occur when a company can generate the most exciting buzz from the market. Excitement means a very exciting price, and that typically means an unexciting outcome for eager investors.

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