Types of Stock Market Transactions (2)

by Maestri

Table 5-1 lists the best performing and the worst performing IPOs of 2001, and it shows how they performed from their offering dates through year-end 2001. As the table shows, not all IPOs are as well received as were Netscape and Boston Chicken. Moreover, even if you are able to identify a “hot” issue, it is often difficult to purchase shares in the initial offering. These deals are generally oversubscribed, which means that the demand for shares at the offering price exceeds the number of shares issued. In such instances, investment bankers favor large institutional investors (who are their best customers), and small investors find it hard, if not impossible, to get in on the ground floor. They can buy the stock in the after-market, but evidence suggests that if you do not get in on the ground floor, the average IPO
underperforms the overall market over the longer run.5

Before you conclude that it isn’t fair to let only the best customers have the stock in an initial offering, think about what it takes to become a best customer. Best customers are usually investors who have done lots of business in the past with the investment banking firm’s brokerage department. In other words, they have paid large sums as commissions in the past, and they are expected to continue doing so in the future. As is so often true, there is no free lunch—most of the investors who get in on the ground floor of an IPO have in fact paid for this privilege.
Finally, it is important to recognize that firms can go public without raising any additional capital. For example, Ford Motor Company was once owned exclusively by the Ford family. When Henry Ford died, he left a substantial part of his stock to the Ford Foundation. Ford Motor went public when the Foundation later sold some of its stock to the general public, even though the company raised no capital in the transaction.

Taken From : Five-Minute MBA – Corporate Finance

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