buying a “hot” IPO stock

recent new issues

There are three recent or current IPOs that I find potentially interesting:

–Chow Tai Fook Jewelry  (1929: HK), a  Hong Kong-based jewelry chain that specializes in chuk kam (pure gold) gold jewelry, but which is expanding its offerings to include Western-style fine jewelry as well,

–Nexon (3659: JP), the Korean company that started the casual gaming craze with Kart Rider–and who, oddly enough, just listed in Tokyo, and

–Zynga (ZNGA), the creator of the Facebook game Farmville (although my interest is mostly in the fact that it’s going public at close to 100x historic earnings).

how to buy them

Suppose you want to buy one of these–or shares in any “hot” IPO.  How do you go about it?

Let’s take it as given that no ordinary retail investor is going to get an allocation of stock in the IPO itself.

Those shares normally go to the most important customers of the brokers who take the company public, not to retail investors or small institutions.  In fact, unless you’re very close relatives or friends of the top management of the company going public–and they use their influence to direct shares your way (how likely is that?)–being offered shares in an IPO in the US as a retail investor is probably a red flag.  It suggests no one higher up in the food chain wants them.  So, to mix metaphors a bit, the underwriters are forced to reach down to the bottom of the barrel to get the deal sold.  In other markets, Hong Kong, for example, there can be special tranches of stock reserved for retail investors.  But the amount of stock you will receive in a “hot” IPO is likely to be very small.

So, to participate we have to buy shares on the open market.

my rules

While every situation is a little different, I’ve found that the rules I developed for myself while I was running a tiny mutual fund in the 1980s (too tiny to get many IPO allocations) have served me well over the years.  They are:

1.  Read the offering documents carefully and try to calculate the rate of growth of future profits.  this is how you decide what price is reasonable to pay. Like any other kind of investment, understanding valuation is by far the most important factor in success.  For a US investor trying to buy a foreign stock this can be a problem, since the documents won’t be available to you (even on the internet) until after the IPO.

2.  If the stock goes down on day 1 (as ZNGA is doing while I’m writing this), that’s a very bad sign.

3.  First day trading can be very volatile.  Use limit orders, not market orders.

4.  Don’t buy the entire position on day 1.  Three reasons, two relating to attempts by institutions to game the IPO system to get better allocations of future issues:

–retail investors may place market orders, driving up the stock price

–some institutions want to be seen by the underwriters as buying stock on the first day.  They think this establishes them as serious long-term shareholders and not “flippers” (people who only want to make a quick profit on getting an IPO allocation and who dump the stock on the market as fast as they can).  Underwriters generally hate flippers, since a large amount of flipping threatens to depress the stock price on day 1, making the issue seem less successful.  So, rightly or wrongly, buying institutions hope they’ll get larger allocations of future issues as a reward.

institutions that want to be seen as regular supports of an underwriters IPOs (i.e., they’ll take anything) and as long-term holders of everything may start to sell after a week or two, when they think underwriters won’t notice, thus preserving their A-list status.

3.  A week or two after the initial trading day, after the IPO hoopla is over and when the institutions I describe in my last point above begin to sell, there may well be a chance to buy the stock at a lower price than on day 1.

4.  Keep a list of interesting stocks you might like to buy but think are too expensive now.  Every so often–too often nowadays, in my opinion–stock markets get frightened and sell off in a crazy way.  Everything goes down; small stocks can go down a lot.

I’ve found these to be excellent times to buy the formerly hot IPO stocks.




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