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Facebook IPO Friend Request…Should You Accept?

May 11, 2012

The trending topic in the investment world is the fact that Facebook is going public.  With the IPO date quickly approaching, we focus today’s show on the ins and outs of initial public offerings and what happens when companies don’t live up to the hype.

An IPO is the first sale of a stock by a company to the public.  It is typically used by a company to expand and become a publicly traded enterprise.

Benefits of going public:

  • Bolstering and diversifying equity base
  • Enabling cheaper access to capital
  • Exposure, prestige, and public image
  • Attracting and retaining better management
  • Facilitating acquisitions
  • Creating more financing opportunities

Disadvantages:

  • Significant costs
  • Ongoing requirement to disclose financial and business information
  • Time, effort, and attention required
  • Risk that required funding will not be raised
  • Must put out a lot of public information that could be useful for competitors

 An Empirical Investigation of Initial Public Offering (IPO) Performance – Zachary A. Smith, Ph.D.
Dr. Smith’s research illustrates that there is usually a pop (possibly due to the stock being undervalued) on day one, negative movement lasting through trading days two through seven, and then stabilization during the lockup provision.  He goes on to report that after IPO’s reach their lockup expiration, they are likely to experience negative performance of approximately .05% points in value each day for approximately one year.  His general conclusion:  when it comes to participating in the IPO market, buyer beware.

A Business Insider article we found also discusses What you need to know before you invest in IPO’s.  Dr. Jay Ritter found that the average three-year return of IPO stocks lagged the average three-year returns of similar non-IPO stocks by 7.2%.  The article suggests that there are other ways to seek high risk – high return trading activity, such as buying options.  The historic long-term performance of IPOs is lackluster in comparison to non-IPO stocks and many who are attracted to this type of investing are listening to the media hype.

We close out today’s show by discussing what we call the “IPO Graveyard”.  Here are some highlights from 15 Companies Whose IPOs Were Complete Flops:

  • Vonage:  The company raised $531 million on the first day, but lost 30% of its value in its first seven days of trading.
  • Webvan:  The company raised $375 million in its IPO, but ultimately filed for bankruptcy and had to lay off some 2,000 employees.
  • eToys:  The company managed to raise a massive $166 million IPO in May 1999, but in February of 2001, the stock tanked to .99 per share.
  • Pets.com:  The company raise $82.5 million in its February 2000 IPO, but went out of business just nine months after going public.
  • Hertz:  Even though it was a household name, this company’s stock barely rose above its starting price of $15 per share on day one of trading.

In general, we are long-term investors and try not to get sidetracked by the “flavor of the week” investments.  That being said, if you love Facebook and want to own it for the sentimental value or to show your support for the company, there is nothing wrong with that.  We just want our listeners to be as informed as possible and make the right choices for your financial success.

If you have any questions for us or want to share some IPO investing stories, please leave a comment or write us on our Facebook wall!

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