Education > Investing > Stocks > Trading IPOs

Trading IPOs

Getting in on a pre-IPO

Investment banks generally give out access to IPOs to their most valuable customers. This is why IPOs are mostly sold to institutional investors, although they are sometimes sold to retail investors who generate large commissions. Some retail brokerages, as a way to differentiate themselves from the competition, have started to give their smaller retail customers access to some of the IPOs that they had a part in underwriting. This practice is not very popular and probably never will be.

Trading recent IPOs

I do sometimes trade recent IPOs but, overall, I am less likely to buy a stock if it a recent IPO. This is because I have 4 problems with IPOs:

First, there is very little fundamental information about the company to analyze. When I buy a stock I like to see at least the last 2 years of annual and quarterly income statements so I can calculate the year-over-year growth rates in earnings and revenue. If it is a stock I have more confidence in for some reason (maybe I know the company well enough to know its growth rate) then the very least I would like to see is last year's EPS or an estimate for the current year's. But sometimes even this is hard to find. Finding fundamental information on IPO companies can be a pain in the ass too because a lot of it will be buried in long documents filed with the SEC. Even though these documents are publicly available, the information takes longer to find because it is not just given straight to you like on Yahoo Finance.

The second problem is that the investing community at large has not scrutinized the company’s financials over a long enough period of time. It is very common for a company to do an IPO and then 3 months or so down the road its stock will drop 30% in 1 day because their sales or earnings came in lower than expectations. This happens all the time. Usually a week after it happens you will see that the company's news page on Yahoo Finance is filled with news releases from many different law firms filing investor class action lawsuits against the company. This happens because the information in the IPO prospectus was incomplete, false, or misleading.

Third, because there is no trading history, I don't know what the market's opinion on the stock is. A lot of amateur traders reading this may consider this non-essential but I assure you it's not. Any sound analysis of an investment must take into consideration the market's expectations.

And finally, the last problem I have with IPOs is that the lack of trading history means there is no support and resistance levels on a chart, which is one of my major criteria when screening stocks. Therefore, there is less technical analysis that can be done.

I'm not saying that IPOs aren't worth looking at. But because they carry specific risks that other stocks don't, you have to be that much more confident in the other pieces of the puzzle. On the upside, IPOs do sometimes give you good opportunities because they tend to be pretty volatile. Also, they often have a habit of following into the same patterns of rising for a short-term right after the IPO, then dropping to new lows. From there the bad companies tend to continue falling and the good companies turn around and starting a sustained up trend.

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