Chances are you’ve at least heard of Candy Crush Saga, the popular digital game with more than 93 million daily active users. To put that in perspective, there are only 12 countries with populations greater than the number of people who mix and match virtual sweets to gain points every day.
The maker of the game, King Digital Entertainment [KING], opened Wednesday on the New York Stock Exchange as the latest tech company to go public in 2014, a year in which industry watchers are expecting increased investor demand for Initial Public Offerings (IPOs).
An IPO is the sale of stock by a private company to the public and can be issued by smaller companies looking to expand or by larger, privately owned firms looking to become publicly traded. While IPOs are often hyped and presented as “once-in-a-lifetime” opportunities, it’s important to know what IPOs really do and who they really benefit. So before you invest your hard-earned savings in the latest market IPO, here are three things you should know:
1. If you’re an individual investor attempting to buy single stocks, you probably won’t benefit from the IPO pricing.
You probably think that investing in an IPO means you’re getting in on the ground floor of a good company. The reality is that unless you’re an institutional investor (e.g. a pension plan or mutual fund), you’re going to find it difficult to get your hands on IPO shares. The average retail investor — you — will likely be buying shares in the secondary market from others who invested earlier at lower prices.
The lesson: Very few people get access to shares at the IPO price.
2. Big buzz + big name doesn’t always = success.
Plenty of IPOs have crashed and burned in recent years. Zynga [ZNGA], the company behind the popular Facebook game Farmville, went public in December 2011 and is currently trading more than 59 percent below its IPO price (as of March 27, 2014). Then again, in 2012 Facebook [FB] itself became the biggest IPO in Internet history — and although its shares tanked after the company went public and it took more than a year for those losses to be recouped, today Facebook is up 45 percent from its IPO price (as of March 27, 2014).
The lesson: IPOs can be risky investments, in part because historical information on the company going public was previously not accessible. It’s hard for professionals, let alone average investors, to predict what a stock will do on its first day of trading. Unless you have a complete understanding about a company’s strategy, balance sheet, future plans, etc., it’s best to sit out its IPO.
3. You don’t have to buy single stocks to get exposure to an IPO.
If an IPO is a truly good investment — and you believe in your fund managers — let them use their professional discretion. When there’s a good IPO available, mutual fund companies can put shares into their funds. For instance, many of the larger mutual funds do have holdings in firms like Google [GOOG] and Facebook, so you’re not going to miss out on having exposure to shares of these companies.
The lesson: Mutual funds can offer you not only professional management and built-in diversification, but exposure to great companies without you gambling your retirement nest egg on individual stocks.
To get a little more insight into IPOs as a worthy investment vehicle for the average investor, We spoke with the management team behind the Laudus U.S. Large Cap Growth Fund [LGILX] to see how they approach IPOs:
“We see each IPO as a unique investment opportunity. Consistent with our research process, we seek to identify companies with sustainable business models … More generally, while we take a glance at most IPOs, at the end of the day many will not meet our rigorous research criteria for inclusion in the portfolio.”
So the next time you hear about a hot IPO coming to the market, think twice about jumping in before doing the necessary research on the company. While some IPOs become very profitable — such as Yahoo, Amazon and Starbucks — many end up selling below IPO prices within a year.
The bottom line?
Just as we advise you not to make changes to your portfolio based on market movements, don’t invest in a stock just because it’s an IPO. Rather, do so because it’s a good investment that fits with your long-term investing strategy based on your individual goals.