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Every serious equity investor knows the potential of IPOs in both Bull and Bear markets. In Bull markets their shares can soar on their first day of trading, driven by momentum and in less ebullient Bear markets, the IPOs are often heavily discounted to attract investors and eventually produce solid returns. So whether the overall equity market is good or bad, smart investors continue to be involved with IPOs.
However, IPO investing is largely the province of large institutional investors; individuals are at a distinct disadvantage. This doesn’t seem fair, but it’s the way Wall Street works.
Despite the much publicized Wall Street Global Settlement and a few IPO reforms made by the stock exchanges with IPO allocations, it’s still pretty much business as usual. The Wall Street system benefits large institutional investors who have relationships with every major underwriter. Institutional investors get the information necessary to make informed decisions: underwriters overnight prospectuses to their doorsteps and invite them to the road show lunch at which the IPO’s management team explains the company’s strategy. The most influential institutions get private “one-on-one” meetings with management.
In contrast, the Wall Street broker who works with individual investors is at the bottom of the food chain. He or she is usually far removed from the powerful capital markets desk, which has the ultimate power to decide who gets IPO shares, and the institutional sales force. The retail broker often receives little or no information about IPOs and has less chance of having allocations of stock to divvy out to clients.
However, there are ways that an informed, determined individual investor can get in on IPO investing. You may not get a lot of shares, maybe 100 if you are lucky. It’s crumbs to Wall Street, but it can be material to an individual investor.
In addition, the SEC has recently made changes in the IPO process to open net road shows to individual investors. And, in a more reform-oriented environment, underwriters may be more willing to boost allocations to individual investors on certain deals.
This primer on investing in IPOs will offer strategies to overcome Wall Street’s bias towards institutional investors, take advantage of the post crash regulatory environment and show you ways to achieve higher returns on IPOs bought after the offering.
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IPO allocations are controlled by the underwriters, specifically the managers listed on the front cover of the preliminary prospectus or “red herring”. The underwriter listed on the upper most left of the red herring is called the lead manager and has the most stock to give out.
The first step to getting IPO allocations is selecting a broker who underwrites a lot of deals. This is a critical decision because unlike an institutional investor, who has accounts with numerous brokers, an individual typically has one brokerage relationship. In addition, you must have an established, active account; brokers are not permitted to make an IPO the account’s first transaction.
Morgan Stanley, Merrill Lynch, Citigroup and UBS Securities are four active, large underwriters who accept individual accounts. Look on the ipohome.com web site for active underwriters.
Another strategy is working with a high quality regional underwriter like William Blair or Raymond James. While their deal volume is considerably lower, they are more oriented to individual investors. Indeed, large, institutional underwriters like Goldman Sachs, Credit Suisse Securities and JP Morgan Chase will use them as co-managers to deliver IPO shares into retail hands.
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Budget-minded investors trading with discount brokers Fidelity, Charles Schwab and E*Trade may have access to limited IPO shares. Fidelity has an alliance with Lehman Brothers to get allocations of Lehman deals and Charles Schwab with Goldman Sachs. E*Trade likewise offers select IPOs. E*Trade says their IPO allocations are made randomly; Fidelity takes into account the size of your account and history. Bear in mind that you must pre-qualify for IPO eligibility. Fidelity requires that you have at least $500,000 at the firm or have done 36 trades within the last 12 months.
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Regrettably, each discount broker punishes customers for quickly dumping IPO shares that go up in price. They discourage “flipping” by imposing fees, 60-day waiting periods and exclusion from future offerings. But, in highly volatile markets investors may be better off making quick exits. A Wall Street IPO committee recently recommended that flipping by individual investors not be punished, but expect the discount brokers to continue their anti-flipping policy.
Institutional investors are under no such constraints. While the underwriters try to place IPOs in the hands of “long-term” holders and steer stock away from day-traders who will flip the IPO within minutes, institutional investors have many ways to dispose of stock quickly and discreetly. In fact, the underwriters of IPOs that rocket on the first day of trading are happy to have stock put back to them. They can turn around and sell the shares to another investor.
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But even institutional investors don’t get all of the shares they want on the offering and make purchases in the aftermarket. Realistically, this is where you can expect to make the majority of your IPO purchases as well.
Investing in IPOs is much different than investing in seasoned stocks. Prior to the offering, there is limited information and research on IPOs. Immediately following the offering, research opinions emanating from the underwriters are invariably positive.
By using the following strategies, you can increase your odds of investing in promising IPOs and avoiding poor performers.
- Be knowledgeable. Find out what’s happening in the IPO market by reading our Annual & Weekly Reviews. You can find out about upcoming IPOs by looking at the upcoming calendars. Check out Upcoming IPOs and Recent Filers.
- Investigate before you invest. Get a copy of the prospectus by using the links in our individual company profiles. Study it. Are there any similar companies that are publicly traded? What are the valuations of these companies?
- View the online roadshow available before the IPO pricing by using the links in our individual company profiles.
- Order Renaissance IPO research reports. Each report digs into the fundamentals of the issuer. We rate each deal based on relative valuation, issuer fundamentals, group momentum relative to the market, and shareholder-oriented issues. Only original source financial data is used. We have a long track record of being able to distinguish the good deals from the bad. Renaissance Capital is the leading source of research on IPOs for prominent institutional investors. Make it your resource.
- Ignore the hype from your broker. The more he or she presses you on an IPO, the more you should be wary. With information from Renaissance Capital you may know more about what’s going on than they do.
- When there is a red hot IPO like Boston Chicken, Tim Horton or Ralph Lauren, fight your feelings that you must own the stock. Wait a day. Wait a week. Every hot consumer-oriented stock with a “drum roll” that preceded its offering has been a major disappointment for investors who bought on the first day.
- Consider spin-offs and large IPOs. Because of the large number of shares to be distributed, the first day “pop” is less. However, these companies tend to be leaders in their industries and consequently receive Wall Street research coverage, broad institutional ownership, and inclusion in indexes.
- Recognize that IPOs of well known consumer brands are often sensitive to individual investor ownership because you are the folks who buy their products. If the management of the company is smart, they’ll keep the offer price reasonable because they know that happy investors are happy customers. They tend to allocate healthier amounts to retail.
- Stick with the IPOs that are underwritten by major firms, well-established regional firms and specialist boutiques. These IPOs are likely to receive research coverage and hence, ongoing investment interest. As a rule, stay away from IPOs by small companies (e.g. under $50 million in proposed market capitalization) and managed by one underwriter. Our calendars automatically screen out the small deals for you. Stay away if you don’t recognize the name of the underwriter or if it has a history of National Association of Securities Dealers violations.
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While individual investors are unlikely to ever equal institutional IPO clout, individuals are far better off than they were.
In the dark days before the Internet, earnings releases and regulatory filings were only available to institutional investors and Wall Street research analysts. The rest of us had to wait to read the information in the next day’s Wall Street Journal. In the meantime, we missed the opportunity to act on timely information. However, the Internet has dramatically expanded the availability of information and speeded up access to it.
The Wall Street reforms contained in the Global Settlement and new rules enacted by the exchanges will have a mixed effect on availability of IPO information and IPO allocations. While the requirement for large brokerage firms to offer independent research to individual investor will increase the availability of diverse views on stocks, it is unclear how quickly individual investors will have access to IPO research. Under current regulations, underwriters must wait 40 days before issuing the initial research opinion. Our Renaissance IPO research is available well before the end of the 40 day “quiet period.”
A troubling development is that Wall Street analysts are now restricted from appearing at the road show and offering their opinions on IPOs. While the Securities and Exchange Commission wants to separate security analysis from underwriting pressures, we wonder whether restricting information flow is a good thing.
As far as IPO allocations are concerned, there have been some marginal improvements. Allocations to favored “friends and family” are reduced. The practice of “spinning” IPO shares to investment banking customers is prohibited. However, the stock exchanges didn’t go far enough to cut off IPO allocations to elected and appointed officials, who in the past have gotten healthy IPO allocations.
Individual investors will never be on the same level as institutional investors. But as long as information flow is improved and exclusionary “old boy” practices are eliminated, individual investors will be better off.
Renaissance Capital’s web site was created to give individual investors access to research reports on IPOs, calendars of upcoming deals and information about the IPO market. Our goal is to level the playing field.
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Attribution Policy: The information contained herein is proprietary and copyrighted. The media is welcome to use our information and ideas, provided that the following sourcing is included: Renaissance Capital's IPOhome.com
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Investment Disclosure: The information and opinions expressed herein were prepared by Renaissance Capital's research analysts and do not constitute an offer to buy or sell any security. Renaissance Capital and/or the IPO Plus Fund (symbol: IPOSX) may have investments in securities of companies mentioned.
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