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A Dollar and a Dream

Jan. 09, 2011 6:06 AM ETGOOG
Ted Stamas profile picture
Ted Stamas's Blog
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Nothing gets investor's juices flowing like the prospect of getting in on the first day of trading of a hot IPO. At first blush, it would seem that this would be easy money to be had if you pick the right security, and there is a lot to be said for that. In recent history, Google (GOOG) comes to mind. Google (GOOG) launched on August 19th, 2004 at $85/share and closed on Friday just under $620. That's a nice return on your investment if you got in on the ground floor. Back in late 1998 and throughout 1999 during the dot.com boom, both institutional and retail investors jockeyed for position to get in on the first day of trading of the IPO's of that era. Fortunes were being made. On the first day of trading alone theglobe.com up 606%, Foundry Networks up 525%, Cobalt Networks up 482%, Marketwatch.com up 474%, Akamai Technologies up 458% and the list goes on. Those days are over, but IPO's are back in the news.

There's been a lot of buzz about Facebook this past week because Goldman Sachs (GS) "agreed to invest $475 million into Facebook and initiated plans to raise as much as $1.5 billion through a special purpose investment vehicle marketed to private wealth management customers. The private sales would value Facebook at $50 billion.", according to Joseph Giannone and Matthew Goldstein on Reuters. If you are a Main Street investor and want to get in on the action over at Facebook, you're out of luck. At this juncture it's only being offered to Goldman Sachs' clients with a two million dollar minimum.

The probability that Facebook will go public in the next year or two is high, but even when it launches its IPO, as a retail investor you should probably let it trade for a year or two and see if you can catch it on a dip, preferably under it's issuance price. Sounds far fetched, but stranger things have happened and if you chase it, you will probably get burned. As is, "Facebook is now considered to be worth more than Time Warner, DuPont and Goldman's rival Morgan Stanley.", says William Cohan of The New York Times in his article "Friends With Benefits". Goldman Sachs (GS) already values Facebook at 25 times revenues as reported in the Rueters article by Giannone and Goldstein. That's a sky high valuation for a company that may not yet be profitable.

There are numerous academic studies exposing the less than stellar returns of IPO's, most notably 2002's "Pseudo Market Timing and the Long-Run Underperformance of IPO's" by Paul Schultz of the University of Notre Dame, which amalgamates previous scholarly studies on the subject. What Mr. Shultz's study concludes is that IPO's just don't beat the market the majority of the time. If you are an institutional investor, it might make sense to take a flier with a small percentage of your portfolio on some technology upstart like a Twitter, Groupon, Zynga, Linkedin or Facebook. After all, institutional investors have millions, if not billions of dollars to invest with and can afford to gamble a few million bucks on the next big thing. Institutional investors also have the luxury of getting in at the opening bell on the first day of trading.

It's not that easy for the retail investor. Individual investors usually have to wait until the institutional firms have flipped their shares to get a piece of the action, and then it may be too late to make a decent profit. There are exceptions like the previously noted Google (GOOG), but like Jason Zweig said said in his Wall Street Journal column on January, 8th when discussing Facebook and IPO's: "For every Google, there are hundreds of companies like eToys and Lycos; for every Apple, there are countless casualties like Thinking Machines and Network Computing Devices.". If investing in individual securities is a bit like casino gambling, then venturing into the IPO market is like playing the nickel slots. Rarely do you win. We tend to have selective memories and hearken back to those salad days of 1999 when playing the IPO market was like shooting fish in a barrel. If only it were that easy.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: Am short the indexes.

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