Ip Os: The Cold Truth For Outsiders

You're in a historic time--a big bang moment. And I don't mean Y2K, N3K (Nasdaq 3000), or any of the other stock-market distractions that can leave you wondering what to do or why you should care. I'm talking IPOs.

You would need the bloodless restraint of Mr. Spock not to feel at least a twinge of longing and regret amid this boom in initial public offerings. It began, for the record, on Nov. 13, 1998, with the 606% gain for Internet portal theglobe.com--big news then as the highest first-day gain ever. Today, stunners are flashing past like so many Pokemon cards (table).

FILTHY RICH. To help sort out what this means for you, I paid a visit to Jay Ritter, a University of Florida professor who has focused on IPOs for 20 years. Just now, he and Tim Loughran of the University of Notre Dame are creating a stir with a study of why companies going public rarely get mad when underwriters price stocks too low. In October's final 10 days, for example, two new stocks--Sycamore Networks (SCMR) and Akamai Technologies (AKAM)--were such hits that if they had been sold initially at the first day's closing price, each would have raised more than $1 billion more. That billion-dollar barrier was not even broached by the era's most glittering deal, last May's IPO of Goldman Sachs (GS). One explanation the professors offer: IPOs are making company insiders so filthy rich that they lose their bearings and blow off millions in potential cash.

That craziness is tough to exploit, since most of the dough winds up with Wall Street bankers and their big-money clients. For those of us consigned to buying shares after they've begun trading, "there's no way to improve the odds" of beating the market, Loughran told me. Just the same, the professors' work details three traits of IPOs that every individual investor should know:

-- CONTEXT COUNTS. On average, IPOs go up the first day they trade. No surprise there, but you should keep in mind that IPOs get a boost from rising markets and suffer when the market has been falling. Loughran and Ritter studied 3,025 new issues from 1990 through 1998. An average IPO gained 14.1% in its first day of trading. But stocks coming public in a market that fell over the prior three weeks saw first-day gains of just 10%. Deals done after the market rose at least 2% gained an average 18.5%. Moral: Check the broader market first.

-- FORGET ECON 101. Higher prices cut the quantity demanded, right? Not, it seems, with IPOs. New issues whose initial prices were revised upward ended their first day with a gain of nearly 32%, more than twice the 14% average, the profs found. Those revised down? A mere 4%. "It's sort of repealing the laws of supply and demand," Ritter told me.

Take Martha Stewart Living Omnimedia's (MSO) recent deal. Underwriters first issued an estimated price range of $13 to $15 a share. As lots of potential buyers emerged, they bumped that up to $16 to $18. Finally, it went public at $18 and, with strong demand, closed the day at $35.56. Raising the price signals an underwriter's confidence, and investors jump on a bandwagon. In 1999, the music is louder than ever: Some 43% of the IPOs that had their initial price raised soared more than 100% their first day. From 1990 to 1998, just 3.7% did so.

-- LONG-RUN DUDS. If changes in the initial offering price tell so much about Day One, do they suggest which IPOs to buy and hold? Loughran and Ritter looked to see if a small investor--that is, one without the clout to get shares at the initial price who instead pays the first day's closing price--could benefit. Sorry. All groups of IPOs, those with initial prices revised up, down, or not at all, trailed the market's total return over three years. Ditto whether they came public in a rising, falling, or flat market. So, amid this superheated IPO moment, what do you do? If you're offered IPO shares before they trade, buying is a fair bet. If not, make like Spock.

Questions? Comments? E-mail barkerportfolio@businessweek.com or fax (321) 728-1711

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