Why shouldn’t you buy Initial Public Offerings (IPOs)? Understanding the negatives behind all the positive hype about investing in IPOs.
Hop on the IPO bull wagon?
The Malaysian market for 2017 appears to have quite a few IPOs lined up. Behind the hype, euphoria, and finger-licking, are IPOs a wise choice for investing?
An Initial Public Offering (IPO) is when a company is first listed to be publicly traded on a stock exchange like Bursa Malaysia. Shares can be listed in any stock exchange in the world provided they meet regulatory guidelines. Different exchanges have different rules (for example, some Singaporean companies are listed in Malaysia because you cannot short-sell shares in Malaysia).
Most of the time, a company that lists for an IPO is a (relatively) new company. Advantages for the company by listing include raising money (capital) without borrowing from a financial institution, and/or to clear off debt. An IPO also allows the founders of the company to exit (usually partially) a company by taking some cash out after their years of contributing blood, sweat, and tears while still retaining control of the company. Listing a company also allows a company to give stock options to employees which can be easily traded. An IPO listing can also be a branding and marketing boost for the company.
A long established private company may also decide to be listed with an IPO (or relisted after being delisted).
10 Reasons Against Buying IPOs
Beyond the hype and hope of making significant immediate profits, there are a number of compelling reasons to consider against investing in an IPO.
- As an investor, you are buying part of a business ownership. With newly listed companies, it is difficult to gauge the value of a company with limited historical public information beyond what is released.
- Whether you are a technical or fundamental investor (or both), there would unlikely be sufficient information to make a wise investment decision.
- IPOs are expensive for individual small investors. You are getting what is left over after selling to large institutional investors at a preferred price. After selling to large institutional investors at a better price, the leftovers are then offered as IPOs and are publicly sold at comparatively higher prices to individual small investors.
- You are hoping for someone to believe that the share is worth more than the IPO price after you buy it during the IPO (aka “bigger fool theory”)
- IPOs are being actively marketed and sold to you by investment bankers and the IPO’s underwriters to generate profits (for both themselves and the owners of the company). Acting as a salesperson, the brightest and rosiest picture of the company listed will be painted.
- The odds are not in your favor when you are being sold by the owners of the company at a price of their choice.It’s almost a mathematical impossibility to imagine that, out of the thousands of things for sale on a given day, the most attractively priced is the one being sold by a knowledgeable seller (company insiders) to a less-knowledgeable buyer (investors). – Warren Buffett
- Historically, most IPOs fall below their initial price in a year from their listing.
- Historically, most IPOs underperform the market in the long term.
- You should buy a company that produces you cash NOT a company that is looking for cash.
- In conclusion, IPO could be an abbreviation for:-
- It’s Probably Overpriced
- Imaginary Profits Only
- Insider’s Private Opportunity
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