Investors are people.
They like novelty; get excited by something new, especially if it holds the promise of making them a whole lot richer and provides bragging rights at their next cocktail party.
Maybe that’s why amateur and professionals tend to lose their minds in bull markets, particularly when a hot initial public offering (IPO) is offered.
During my school days in a marketing class I was taught about introverts - shy people who are very careful about any product in finance. We called them risk averse. These people will only do something after seeing others doing it.
Good for the risk but very bad for return. There are extroverts too - very outgoing. I go with this group because as much as there is higher chance of losing money there is a high chance of gaining it also.
On one hand, had you bought into the initial public offering of other previous initial public offering you may have had some volatile price fluctuations along the way but there is no question that you have made enough money to substantially change the quality of your life.
An IPO is the first sale of stock by a company to the public. A company can raise money by issuing either debt or equity. If the company has never issued equity to the public, it’s known as an IPO.
Companies fall into two broad categories: private and public. A privately held company has fewer shareholders and its owners don’t have to disclose much information about the company. Anybody can go out and incorporate a company - just put in some money, file the right legal documents and follow the reporting rules of your jurisdiction. Most small businesses are privately held and large companies can be private too.
It usually isn’t possible to buy shares in a private company. You can approach the owners about investing but they’re not obligated to sell you anything. Public companies, on the other hand, have sold at least a portion of themselves to the public and trade on a stock exchange. This is why doing an IPO is also referred to as ‘going public’.
Public companies have thousands of shareholders and are subject to strict rules and regulations. They must have a board of directors and they must report financial information every quarter.
From an investor’s standpoint, the most exciting thing about a public company is that the stock is traded on the open market, like any other commodity. If you have the cash, you can invest. The CEO could hate your guts but there’s nothing they could do to stop you from buying stock.
A single share of Coca-Cola purchased for $40 at the IPO in 1919, for example, crashed to $19 the following year. Yet, today, that one share, with dividends reinvested, is worth over $5 million.
Clearly, a well chosen IPO investment can be a life-changing experience if you simply make the right choice and stick the stock certificates in your safety deposit box for 30 years. On the other hand, are companies such as WebVan, the bankrupt web grocer that left investors licking their wounds and draining their portfolio of precious capital.
Benjamin Graham, the father of value investing and much of modern security analysis, advises in his treatise: The Intelligent Investor that investors steer clear of all IPOs because during an IPO, the previous owners are attempting to raise capital for expanding the business, cash out their interest for estate planning or any other myriad of reasons that all result in one thing: a premium price that offers little chance for buying your stake at a discount.
Often, he argued, some hiccups in the business will cause the stock price to collapse within a few years, giving the value minded investor an opportunity to load up on the company they admire. As even our Coca-Cola example proved, this often turns out to be case.
The problem comes from the fact that if you find a truly outstanding business – one that you have conviction will continue to compound for decades at rates many times that of the general market; even a high price can be a bargain.
Indeed, looking back a decade ago, Dell Computer was an absolute steal at a price to earnings ratio of 50%! It was, in fact, the ultimate value stock.
Given the difficulty of sorting out the chaff from the wheat, you are probably going to do better by sticking to your guns. In theory, Graham’s position is one of conservative, disciplined safety. It ensures you won’t get burnt and the average investor will likely be well served in the long-run by adhering to that principle.