Gene Proctor’s interest in buying stocks of companies the moment they go public dates back some 15 years, when he tried to buy into a small trucking parts company.
It didn’t work. Proctor’s broker couldn’t get any of the shares.
Proctor tried again in 1986 with a company that makes quality control instruments for paint, plastics and textiles. Again, no luck.
But Proctor lucked out last November, when he bought 100 shares of Universal Forest Products Inc. Within a month the stock rose from the initial offering price of $7 a share to $8.75, a 25 percent increase. By year’s end, the stock hit $11, a 57.14 percent increase from Proctor’s original purchase price.
Since then, however, the stock-along with the rest of the market-has headed in the other direction. Universal recently has traded at around $7.50.
Proctor is still optimistic the investment will prove a good one-Universal Forest Products does get good marks from many analysts-but if he makes a killing on his initial public offering investment, Proctor will be the exception. More often, small investors who take fliers on IPOs are disappointed.
“It’s kind of sad,” said Robert Liu of Securities Data Corp., a New Jersey company that tracks IPOs. “The little guy really can’t take advantage of them.”
Understanding why small investors are at a disadvantage requires understanding a little of how IPOs are sold.
Companies going public want to raise money as quickly and as easily as possible.
Usually, one or more brokerages will contact institutional investors, such as pension or mutual fund managers, who frequently agree to buy as much as 60 to 70 percent of the available shares before they come to market.
The rest are doled out to aggressive brokers within the firms who contact their more affluent, commission-generating customers as a payback for all their business.
The only time many small investors can get in the game is after an issue already has hit the markets. And often, waiting even a day means you have waited too long.
“For the little guy to have a better chance, he’s going to have to be an active, commission-generating account for the broker,” said David Menlow, president of IPO Financial Network, a Springfield, N.J., research firm.
That generally was the system used last November when Boston Chicken, one of the most publicized IPOs, went to market.
Some institutional investors and well-heeled speculators were able to buy Boston Chicken at its $20 a share offer price. But when trading started the morning of Nov. 9, the popular franchise opened at $46. Boston Chicken rose to a high of $51 a share that day, a 155 percent increase from its offer price, the largest single-day jump in IPO history.
Boston Chicken recently traded at around $38, below what many people paid last November.
Granted, Boston Chicken was an exceptionally volatile issue, but part of an IPO’s allure is its potential volatility and the hope of making a lot of money. In the past three years, many IPOs have made good on that promise.
In 1992, IPOs returned an average 31.2 percent, compared with 10.5 percent for the Standard & Poor’s 500. In 1993, IPOs returned 24.9 percent on average, compared with 8.6 percent for the S&P 500. Through the first four months of this year, IPO prices increased on average only 1.6 percent. But during that same time, the S&P 500 was down 3.2 percent.
“IPOs have done tremendously well,” said Securities Data’s Liu. “The market has been red-hot.”
Part of the reason has to do with the favorable economic environment Wall Street has enjoyed.
“The conditions were perfect,” Liu said. “Low interest rates. Plenty of people with money to invest.”
The heady pace with which IPOs have been coming to market may be slowing, in part because the market has cooled.
“I know of two companies that were considering IPOs,” said Aggie Monfette, a broker with A.G. Edwards & Sons Inc. “But they’re waiting because of the current market conditions.”
A larger question is whether IPOs are as strong an investment for small investors as their statistics suggest.
In March, Prudential Securities investment analyst Claudia Mott reviewed 1,500 IPOs that came to market since 1991.
Her conclusion: Those who bought IPOs after the offering day realized average gains of only 0.1 percentage point after the first week. After three months, the average return for IPOs bought at the offer price was an enviable 20.7 percent. But the average return for IPOs bought the first day of trading was only 8.5 percent.
For small investors, making money speculating on IPOs can be a daunting task, but there are some actions they can take to help even the odds.
– If you hear that a particular company is going public, call the company to find out the underwriter or underwriters. Your personal stockbroker may not have access to shares at the offering price, but the underwriter certainly does.
– Contact mutual funds that tend to seek out IPOs as part of their overall portfolios. T. Rowe Price’s OTC, Small Cap Value and New Horizons funds include IPOs within their portfolios (800-638-5660; five-year annualized returns are 10.69 percent, 15.11 percent and 17.67 percent, respectively). The Kaufmann Fund also loads up on IPOs (800-237-0132; five-year annualized return is about 25 percent), as does Oppenheimer’s Discovery fund (800-525-7048; five-year annualized return is 17.54 percent).
These funds are not for the fainthearted. But because you are buying into a mutual fund that mixes IPOs with other types of stocks, your risk is reduced.
– Consider buying into your IPO stock 6 to 12 months after it goes public. A study by David L. Babson & Co., Boston-based investment bankers, found that more than 70 percent of IPOs underperformed investor growth expectations within the first six months of the offer.
That’s partly due to profit-taking by institutional investors. If you wait up to a year, the IPO issue should be free of speculators, and you can concentrate on serious, long-term investing.
– Don’t buy into an IPO if a broker calls you. It’s hard enough for brokers to get access to the good IPO offerings. If anything, heavy-hitting brokers complain they don’t have enough shares to meet their demand. If a broker calls you, there’s a good chance the issue is a loser.
