Why You Can’t Snap Up A Stock at the IPO and That’s OK.

sticker-mule-199257Google, Netflix, Facebook, Amazon, Twitter, LinkedIn and now Snapchat. The list of “hot” companies that have gone public in recent years is long indeed. Not surprisingly, when popular companies go public the interest in purchasing shares of their stock at the Initial Public Offering or IPO always spikes.

Who wouldn’t want to get in on the ground floor of what may be the next big thing?

Unfortunately, you and I will likely never be able to buy in to the next big thing at the IPO and that’s not necessarily a bad thing.

Here’s why:

When a company decides to raise money by selling shares of stock, they go to what is called an underwriting company, usually an investment bank or major brokerage firm, to help them with this process. There are different ways an underwriting company can put together the deal, but part of their job is to sell the stock to large investors prior to the actual start of trading on the public stock markets.

These opportunities are almost never available to the average retail investor. Typically only institutional investors, mutual funds, hedge funds, super high net worth individuals, and other investment banks get the chance to buy a stock at its IPO.

Unless you are an active trader with a very large account at one of Wall Street’s major brokerage firms (Goldman Sachs, Morgan Stanley, etc.) and are prepared to purchase a large block of shares (maybe a million shares or more), you will have to wait until the shares trade on public exchanges like NASDAQ or the New York Stock Exchange (NYSE). Once a company goes public anyone can buy or sell their shares.

That’s OK

Let the large institutional investors stick their neck out first. Sometimes it pays off, often it doesn’t. While share prices may spike in the hours and days following the IPO, longer-term investors may be disappointed with their total return over time.

Sometimes it pays to wait.

According to a white paper by the law firm WilmerHale, the average 2015 IPO produced a first day gain of 16% – a relatively high percentage compared to previous years. Not bad for a one day trade. However, it doesn’t always work out that way. Of all the companies that went public in 2015 only about ¼ of them saw their stock price decline on the first day of trading. A year after their IPO most companies traded below their initial IPO price. Nevertheless, there are some successes. Of companies that went public in 2015, 28% experienced gains of 20% or more a year later.

Similar research by Jay Ritter of the University of Florida found that buying an IPO and holding it over the following three years produced a return that was less than that of the market especially for smaller companies.

None of this is to suggest that buying the stock of a newly public company is always a bad idea. Depending on the company, your risk tolerance and other factors, investing a portion of your savings into these companies could pay off. However, just because you missed the IPO doesn’t mean you have missed out on an investment opportunity forever. As the numbers above suggest, in some cases you may actually be able to pick up your favorite IPO at a stock price that is below its original IPO price long after it’s gone public.

Invest. Don’t speculate.

Take your time, do your research and make investment decisions based on facts not emotion. Unlike a post on Snapchat, your best long-term investment opportunities won’t disappear overnight.

If an investment has good long-term potential, it will be a wise choice for some time to come, presenting various buying opportunities to snap it up along the way.