Credit: Shutterstock photoFor successful investors, most decisions are pretty calculated and devoid of emotion. That is no accident; emotion is the enemy of successful trading and investing. It robs you of rationality and can blind you to the obvious. Even for old hands, though, that soulless approach can become wearying. As human beings we need some degree of hope and excitement and even the most cynical financial type likes to feel that in some way they are doing good. That is the only explanation I can think of for the trading that takes place on day one of most Initial Public Offerings (IPOs), particularly in the case of high profile companies.
Think about it. How often does a stock debut and then trade higher in the next week? On the first trading day it will usually open higher than the initial offering price and sometimes even climb from the opening that day, but rarely is a new stock higher after a week or so of trading. Just look at the first two weeks of trading in Twitter (TWTR), for example. The offering price of $26 almost doubled in the first day, but anybody who went long that day had to wait over a month for a chance to rake a profit.
Oh, and if you think that this is purely a tech phenomenon, take a look at the first few days of trading in American Airlines (AAL) and think again.
Of course there are exceptions, but this pattern of day one strength then a period of weakness, regardless of the potential or eventual long term performance of the stock concerned, is remarkably common. It is also remarkably unsurprising.
The merchant banking divisions of major banks contain some of the smartest minds in the world and when the big banks combine, as they usually do for high profile IPOs, the brain power behind the pricing of the stock is frightening. It is little wonder then that they can usually find the optimal price that will ensure a decent return for initial investors, while still maximizing revenue for the company. What is a source of wonder is that, despite that oft repeated pattern, the first day of trading in new stock so often sees such enthusiastic buying from the general public. That is where the whole hope and excitement thing and the warm and fuzzy feeling that comes from being useful come into play.
Buying into a new company is, by its nature exciting. There always seem to be endless possibilities for growth. Every stock looks about to do a Google (GOOG) and appreciate exponentially. It also leaves investors feeling good about themselves. Providing capital to young companies is what we tell ourselves we are doing when we play the market ... it isn’t gambling or greed when you are the foundation of the capitalist system!
Most retail investors get little or no chance of buying new stock at the offering price, however. The vast majority of high profile offerings are bought by large funds and even when an allocation is released to retail investors it is controlled by the brokers who naturally offer it first to their biggest (aka highest fee-paying) clients. By the time the big boys are finished there is very little left for you and me. The sense of frustration, of being left out, that that causes just adds to the desire to be in on the deal and that, when combined with the whole hope and doing good things, usually means that there is no shortage of willing buyers in early trading.
The optimum strategy for investing in high profile initial offerings becomes obvious when you consider all of this. If you can buy at the actual offer price, do so and then sell on the first day of trading. If you see the company as a long term investment, the chances are that you will be able to buy back in at close to the offer price in the near future. If you don’t receive an initial allocation, patience is needed.
Wait for the dip that usually follows the first day of trading. The optimum valuation by investment bankers makes it extremely unlikely that there will be a rapid climb in the stock, so you aren’t risking much by waiting, but the stock can very often be bought at a substantial discount to the first day price over the next couple of weeks.
Investing in newly public companies has advantages that go beyond the obvious potential for huge gains over time. It can also be an outlet for much of the emotion that successful traders and investors suppress, which is undoubtedly a good thing. Going into those investments with a strategy, however, will save a lot of heartache and probably a lot of money.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
