4. Be cautious
Skepticism is a positive attribute to cultivate in the IPO market. As we mentioned earlier, there is always plenty of uncertainty surrounding IPOs, mainly because of the lack of available information. You should always approach an IPO with caution.
If your broker recommends an IPO, you should exercise even more skepticism. This is a clear indication that most institutions and money managers have passed on the underwriter's attempts to sell them stock. In this situation, individual investors are likely getting the leftovers that the "big money" didn't want.
If your broker is strongly pitching shares, there is probably a reason behind the high number of these available stocks. This brings up an important point: Even if you find a company going public that you deem to be a worthwhile investment, it's possible you won't be able to get shares. Brokers have a habit of saving their IPO allocations for favored clients, so unless you are a high roller, chances are good that you won't be able to get in.
5. Consider waiting for the lock-up period to end
The lock-up period is a legally binding contract (of three to 24 months) between the underwriters and company insiders prohibiting large shareholders from selling the stock for a specified period. Take, for example, Jim Cramer, the founder of TheStreet (TST) and a contributor to MSN Money's Top Stocks blog. At the height of TheStreet's stock price, the paper worth of Cramer's shares was in the dozens of millions of dollars. But Cramer knew the stock was overpriced and would soon come down to earth, along with his personal wealth. Because this happened during the lock-up period, even if Cramer had wanted to sell, he was legally forbidden to do so. When lock-ups expire, the previously restricted parties are permitted to sell their stock.
The point here is that waiting until insiders are free to sell their shares is not a bad strategy, because if they continue to hold the stock once the lock-up period has expired, it may be an indication that the company has a bright and sustainable future. During the lock-up period, there is no way to tell whether insiders would be happy to take the spot price of the stock.
Let the market take its course before you take the plunge. A good company is still going to be a good company, and a worthy investment, even after the lock-up period expires.
The bottom line
By no means are we suggesting that all IPOs should be avoided; some investors who have bought stocks at the IPO prices have been rewarded handsomely. Every month, successful companies go public, but it is difficult to sift through the riffraff to find the investments with the most potential. Keep in mind that when it comes to dealing with the IPO market, a skeptical and informed investor is likely to perform much better than one who is not.
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