IPOs -- initial public offerings of stock -- are the financial
world's Super Bowl. The enthusiasm, anticipation, and chance to
make millions out of seemingly nothing are what drive investor's
In this year's third quarter, the three top-performing IPOs
Sprouts Farmers Market (Nasdaq:
Rocket Fuel (Nasdaq:
, up 123%, 102% and 93%, respectively, in their first day of
trading. Even if you hadn't heard of these three offerings,
big-name IPOs such as
have been on nearly everyone's radar due to massive media
Not only do many IPOs make the company's founders and initial
investors wealthy, initial offerings usually provide much-needed
cash to expand operations (and increase shareholder value). The
problem for most investors is that it's difficult if not
impossible to obtain IPO shares before they're listed. These
shares go to insiders and others with special relationships with
the investment house issuing the shares.
There are some "backdoor" ways in which regular investors can
profit from the first day of an IPO: for example, in the case of
Twitter's IPO, investing in a high-tech incubator like Japan's
Digital Garage or a fund like
GSV Firsthand Technology Value Fund (Nasdaq:
that owns Twitter's pre-public shares. However, in the case of
Twitter, these strategies fell sharply on the day of the IPO -- a
classic case of "buying the hype and selling the facts."
While this isn't always the case, it illustrates that IPO
investing can be very risky, even for insiders. All you need to
do is look at
to realize that not every IPO is successful on its first day.
According to the ETF Database, there have been 195 new company
listings this year, with an average first-day gain of
17%. However, several IPOs have been massive losers:
, for instance, plunged 64% on its first day of trading.
This underscores the volatility of IPOs in general. Some
investors try to time an IPO's first-day upward trend. While this
strategy can work, it is very risky, and I don't suggest it to
anyone without strong day-trading skills.
Not only can IPOs outperform on the date of issue, but they
often continue their winning ways after their debut. For example
the FTSE Renaissance U.S. IPO Index is up over 40% this year
alone, roughly double the S&P 500 Index's return of 22%.
In my opinion, the best and safest way to capture the
longer-term gains of IPOs is with an exchange-traded fund (
). My favorite IPO-based ETF is the
First Trust IPOX-100 (NYSE:
, which is up 38% this year and boasts an impressive five-year
average return of 24%. With more than $240 million of assets,
this ETF is in the large-growth fund category. It has a 10% cap
on stock weighting within the portfolio to ensure proper
Most interestingly, the IPOX index itself is governed by rules
intended to reduce volatility. For instance, the index does not
hold any stock that exhibited more than a 50% gain on its first
day of trading. Companies must have market caps of at least $50
million, and stocks are added to the index only after a seven-day
post-IPO waiting period. Finally, the index discards any IPO
after 1,000 trading days. This keeps the index in tune with the
present state of the IPO market.
Risks to Consider:
This has been a stellar year for IPOs, thanks to a receptive
market, low interest rates and accommodative monetary policy.
However, if the economic picture shifts in a bearish direction,
the IPO market will be among the first to suffer the
consequences. Always use stop-loss orders and diversify properly
Action to Take -->
You couldn't ask for a more picture-perfect daily chart. FPX has
been trending up since January 2012, with the 50-day simple
moving average acting as solid support for the advance. Every
pullback to that support level has been aggressively purchased.
Right now, shares have hit resistance, and price is consolidating
right below the $43 level. Buying a breakout close above $43 with
initial stops at $39 and a 12-month target of $53 makes investing
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