How Individual Investors Should Invest in IPOs

When a Company Like Facebook Goes Public

Ronald Parker invested in Facebook before its IPO

Events of worldwide significance, including the Greek debt crisis and plunging oil prices, couldn’t compete with Facebook’s initial public offering for investors’ attention on the popular social networking service that launched in February 2004. There were highs and lows, as the stock rose to $45 a share and retreated to around $25. As of this writing, the stock trades around $32, off from its $38 IPO price.

Ronald Parker of Baltimore set his eyes on Facebook before the first day of trading. Using his Fidelity Investments brokerage account, he purchased 300 shares at $42 each, and another 200 shares at $36. Parker concedes that most small individual investors are shut out of buying hot issues because brokerage firms allocate IPO shares to institutions and other prime customers.

While most investors focus long term–and rightly so–investing in stocks and mutual funds through their 401(k) plans, Parker says some dividend-seeking investors look for stocks that are going to pay them 3% to 5%. Then there are traders like himself who identify high-growth companies such as Google and Facebook that move up and down in price.

Parker has since sold 200 shares of Facebook, buying and selling some put options once its stock price fell to $27 a share. In simple terms, there are two kinds of contracts options: “calls” let an investor buy a certain stock at a  price and “puts” let an investor sell it at a certain  price. Calls are generally used by investors who want to profit from a rise in stock prices, but avoid sharp losses. A put is used by investors seeking to profit from a fall in stock prices by selling the stock at a higher price quoted in the put before its expiration date.

Parker still owns 300 shares of Facebook. He wants to wait it out. “Most high-tech stocks would be making a lot of money if it weren’t for the economy and European debt crisis. But I still believe that tech is going to be a main driver,” he says.

Does the Facebook price saga indicate that individual investors should shy away from IPOs? Not necessarily. “For the most part, IPOs are usually underpriced. They tend to perform well in the first year of public trading,” says Shawn D. Baldwin, chairman and CEO of Capital Management Group, a boutique investment bank and research advisory firm in Chicago. Baldwin’s firm has participated in more than $68 billion in underwritings, including success stories such as Google, in which CMG was a co-manager. Baldwin says sometimes it’s better for individual investors to wait a while and see how the stock does after its IPO to find a good buying opportunity. “Look hard at the company and its industry before you invest.”

Indeed, companies that are now household names–Microsoft, Google, Intel, Walmart, Home Depot, Disney, Dell, Coca-Cola, Target, Starbucks, etc.–were once IPOs. If you had invested in any of these, you may have had some volatile price fluctuations along the way, but over the years you would have made enough money to substantially change the quality of your life.

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