Beware the IPO juggernaut

Initial public offerings are hot, but hot items can be too hot to handle and burn the unwary. That’s a message investment advisers should drive home to even their more sophisticated clients. As reported by InvestmentNews‘ Jeff Benjamin, 169 companies have filed to go public this year to date, compared with 256 for all of 2013, with the proceeds totaling $23.5 billion, versus $54.9 billion last year.
Along with this flood of IPOs are anecdotes of New York cab drivers discussing the latest big-deal offering with passengers — a reliable sign of overheating. And that’s before what promises to be this year’s biggest IPO: the $15 billion stock offering by Alibaba Group Holdings — aka, the Amazon.com Inc. of China.
The event will almost certainly attract great attention to the market. Alibaba, with net income of $3.6 billion on revenue of almost $8 billion last year and more than 20,000 employees, dominates the online retail business in China.
In addition, the company’s margins are much higher than those of its two U.S. competitors, Amazon and eBay Inc., so it is an attractive story for investors.

GROWTH STOCK

E-commerce is still small in China but is expanding rapidly, which makes Alibaba a growth stock. And the company probably will want to enter the U.S. market in competition with Amazon and eBay in the future.
However, the average investor is unlikely to get even a whiff of Alibaba’s IPO shares, which almost certainly will be snapped up by institutional investors and the wealthiest customers of the investment banks handling the offering.
And that’s OK.
Many investors will be tempted to buy the shares as they become available in the days after the IPO, but advisers should warn their clients that the shares of even the most scorching IPOs don’t necessarily continue to rise after a successful first day.
Facebook shares declined for the first six months of trading and took 14 months to get back to the offering price.
Even more might be tempted to buy shares in follow-on offerings when company insiders sell some of their shares. But such offerings have been poor performers in the past six months, with shares of some initially high-flying companies declining more than 50% after the offerings.
A torrid IPO environment also can pose danger to investors’ well-being in that it often helps inflate the market as a whole to unhealthy levels.

DISTURBING RESEMBLANCE

The sizzling IPO market of 1998-2000 signaled the evaporation of the dot-com bubble. It was followed by a bear market that slammed technology stocks as well as the broader market.

Some analysts suggest that the current IPO market is starting to look a lot like that 1998-2000 bubble. It might be time to be cautious.

The best advice for investors who can’t get into superheated IPOs at the beginning is to wait until the hoopla has died down and the insiders have sold some of their holdings — to see if the company is fulfilling its pre-IPO promise. If it is, they can buy the stock as a long-term holding.

Investors who are looking for some of the thrill of the IPO but who lack access to the initial offering can get involved through the few mutual funds that invest in them, but those investors should be prepared for a volatile ride.

Taking a page from baseball’s playbook, advisers should remind their clients that the best long-term investment approach is to aim for consistently hitting singles: buying either diversified portfolios of good companies with steady earnings and solid balance sheets, or well-run mutual funds.

Related Topics: Initial Public Offerings (IPO)