A single share of Johnson & Johnson purchased for $37.50 at the IPO in 1944, after stock splits and reinvested dividends, would be worth more than $1 million today. Similarly, a $5,000 investment in Walmart’s IPO for $16.50 per share in October 1970Â would be worth more than $60 million. Clearly, a well-chosen IPO investment can be a financial boost if you make sound choices and hold on to them. On the other hand, companies such as WebVan, the bankrupt Web grocer, and Pets.com have left investors with large losses.
So how do you increase your chances of finding a Google instead of a Webvan? “Do the work,†says Carla Harris, a managing director with Morgan Stanley in New York. “You can do it yourself or trust that your financial adviser has done it carefully.â€
The work, in this case, is looking into an IPO company’s background and evaluating its future prospects. “Read the IPO prospectus and other offering materials,†says Harris, who has executed such transactions as IPOs for UPS and Martha Stewart Living Omnimedia. “Look at the trajectory of sales, earnings, and read the risk factors that are listed and evaluate them.†As a result of your research, you should be able to make a cogent argument for investing. “You should be able to explain why you think the company will perform well,†she adds.
Besides checking on the outlook for individual IPOs, you may be able to use broad market trends as a guideline for investing. “Our data show that IPOs historically outperform the broad stock market, coming out of periods of low issuance,†says Kathleen Shelton Smith, a principal at Renaissance Capital, an IPO investment advisory firm in Greenwich, Connecticut, and a leading source for IPO research and analysis. After the August 2008—February 2009 and the August 2011—September 2011 stock market downturns, during which IPO issuance dried up, IPO stocks outperformed the major market indexes. The average return on all IPOs priced in the first half of 2012 was 20.8%, says Shelton Smith. Only the strongest, most attractively valued IPOs are able to come to market in such environments, and those stocks generally do well once trading begins.
“We are now in a period of minimal IPO issuance,†says Shelton Smith, “and I’m not sure how long it will last.†For any investors still eyeing Facebook, she suggests to first wait for confidence to return to the broader equity markets. Second, look for Facebook to apparently find a bottom; that is, the stock will stop dropping. With a class action filed against Facebook for not disclosing information about its IPO to the public, “investors should factor in the negative consequences of management distraction, legal costs, possible dollar settlements, and reputational risks of these pending lawsuits,†she adds. “Also, new IPOs will start up again,†says Shelton Smith. “These new IPOs probably will be priced attractively at that point because most investors will not have forgotten the Facebook disaster.â€
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