Patience Required for Small Investors to Cash in on IPOs

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In the old days (say, two years ago), stockbrokers joked that IPO meant “it’s probably overpriced.” Better words today might be, “I’m practically obsessed.”

IPO actually means “initial public offering.” That’s the first time a company sells its shares to the public.

Everybody wants a piece. Led by the Net and tech stocks, IPOs set all-time records last year, says Jay Ritter, professor of finance at the University of Florida in Gainesville.

On their first day of trading, they soared an average of 70 percent, compared with just 14 percent between 1990 and 1998. In trading after the first day (known as the “aftermarket”), gains averaged 69 percent.

So who gets this free money a $15 stock that could zip to $50 the first day it trades? Bend your ear while I whisper: not you.

Up to 85 percent of an IPO goes to institutions, such as mutual funds and pension funds. A handful of brokerage firms get the rest, to allocate to customers.

Mostly, they’re the traditional, full-service firms. Online firms get pieces of deals, but not nearly enough to satisfy their soaring numbers of accounts, says Daniel Burke of Gomez Advisors, an e-commerce research firm in Lincoln, Mass.

To get on the list, you first have to do business with a firm that offers IPOs. At the majors you also have to have serious money. Merrill Lynch and DLJdirect want at least $100,000 in your account; Fidelity wants $500,000; Charles Schwab wants $1 million.

Alternatively, you might make the cut by trading hyperactively but that takes money, too.

Lesser money should check Wit Capital, which lowers the bar to $2,000. At E-Trade, you need to have only enough in your account to cover the buy.

The online brokerage firms have general rules about who gets IPOs. DLJdirect considers how long you’ve been a client and how actively you trade. E-Trade reserves a percentage for its beloved heavy traders, but allocates shares randomly. Wit allocates first to customers who bid for the shares on the day the prospectus is released.

Typically, online customers get IPOs in 100-share lots, although E-Trade is thinking of reducing that amount.

What you especially need is access to better IPOs. The best IPOs are those still owned by institutions three months after trading starts, says Laura Casares Field, assistant professor of finance at Penn State University. They sell (or “flip”) the poorer stocks into the public’s hands.

Online brokers, by the way, don’t want you to flip your stock, which they generally define as selling within the first 30 or 60 days. Flippers hurt the brokers’ chance of getting more IPOs to sell. If you break their rules, you’ll be off their list. But flipping a winner is the very heart of the dream.

There’s one sure way of owning IPOs: buy one of the small-cap mutual funds that get the shares. Recently, Janus Venture had 25 percent of its money in stocks that went public in 1999. The sizzling First American Technology had 27 percent.

For even more focus, look at the two-year-old, $93 million IPO Plus Aftermarket Fund. It’s run by Renaissance Capital, which specializes in IPO research.

The fund rose 18.3 percent in 1998, during a generally punk year for smaller stocks. In last year’s boom, it soared 115 percent. Investors got a wild ride, with sudden drops of 28 percent or more. But mutual funds can recover, while many faddish IPOs might not.

Here’s this column’s best tip on individual IPOs: Your biggest gains might be made in the aftermarket, where anyone can play.

IPO Plus’ Kathleen Shelton Smith advises you to check an IPO you like one week after the opening hype, to see if the price came down. A second price pop might occur after 30 days (that’s when the sponsoring brokers’ lap-dog analysts publish their predictably rosy forecasts).

If the stock still looks too high, check it again in 180 days. That’s the typical “end of lockup date,” when the company’s insiders can sell. Typically, they unload big and the stock price drops.

You can check unlock dates at IPO Plus’ Web site, ipohome.com. Some companies now let the insiders bail out after 60 days.

IPOs aren’t long-term holdings. Over five-year periods, they underperform seasoned companies of similar size by 5.1 percent a year, professor Ritter says. How can you stay on top of the fads that blow in and blow out? Let a mutual fund do your trading for you.

Syndicated columnist Jane Bryant Quinn can be reached in care of the Washington Post Writers Group, 1150 15th St., Washington D.C. 20071-9200.

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