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Canada's Most Wanted

People get too excited about IPO's (Initial Public Offering) because of the overly-optimistic outlook painted by analysts, mutual fund managers and investment advisors. This is usually nothing but hype. As a result, the shares of an IPO company have a spectacular performance on the first day of trading. An IPO is a corporation's first offering of stock to the public. Thus, the popular term "going public" refers to an IPO of a corporation.

A recent example was the much anticipated and most wanted Tim Hortons Inc. IPO on the Toronto Stock Exchange on March 24th, 2006. There was even a big party at the Toronto Stock Exchange to celebrate the going public of a Canadian icon. The IPO was richly priced at C$27.00, and when trading opened at 09:30, the shares shot up to almost $38.00 (+40%) and closed the day at $33.10 for a gain of over 22%. The 22% "gain" was reported nation wide in television news, the radio and newspapers.

But wait, would an "average investor" have made any money from this IPO? The answer is sadly... no. In fact, an average investor would have lost money in this IPO!

Most people do not think about this but normally only mutual funds and some high net-worth investors (also known as "sophisticated investors" - i.e. those who have at least $500,000 to invest in an IPO) are actually able to purchase shares at the IPO price - i.e. in the primary market.

So, it would have been almost impossible for an average investor to purchase Tim Hortons' shares at the IPO price of $27.00. An average investor would have had to purchase shares once they started trading on the stock exchange - i.e. in the secondary market.

If the shares were purchased when trading opened on the first day at $37.99, at the end of the day the investor would have lost 29% of the principal! In fact, shares purchased at almost any time on the first day would have resulted in a loss by the end of the day.

Here's a high-low-close chart of Tim Hortons since it's debut in late March 2006. Notice how the shares having been treading lower since the debut getting closer and closer to the IPO price of $27.00.

There are two good reasons why one should stay away from IPO's:

1. New issues have special salesmanship behind them, which calls therefore for a special degree of sales resistance.

2. Most new issues are sold under "favourable market conditions" - which means favourable for the seller and consequently less favourable for the buyer.

For every IPO that makes money for the investors in the first year of trading, there are ten that lose money for their investors.

Often, it is best to wait for the excitement and optimism to fade away to make purchases of new public companies.

2 comments:

Intrepid said...

But what about in booming markets, such as on the Bombay Stock Exchange? The IPO "bubble" usually does result in the small investor making some money. But then again, as a retail investor, the actual number of shares allocated is so small, I sometimes wonder if the time spent in filling up those application forms is worth it. Then there's always IPO scams like the recent one, where large brokers and registration companies colluded to create tens of thousand of fake accounts and apply in the retail category. In the end, I guess it's the same adage, "If it looks too good to be true, it probably is".

Can't C Me said...

One has to be especially careful in booming markets because a lot of lower quality IPOs are sold to the public.

Like you said, the IPO "bubble" may make money to the small investor, but once the bubble bursts and it always does, the small investor will suffer heavy losses.

 
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