I’ve been following IPOs since the mid-1990s, and along the way, I’ve seen some interesting patterns. But perhaps the most important to investors like you and I is that if you wait six months to a year after an offering, you’ll almost always get a much better price.
Cue Twitter (TWTR).
Twitter stock came public back in early November to heavy demand. The price range for TWTR increased before the offering, then Twitter stock soared 73% to $45 on the first day.
By the end of 2013, TWTR approached $75, and it seemed like investors would never get in for cheaper than they could have on that first day.
Dream turned to nightmare for the bulls, with Twitter stock plummeting some 60% from its late-December highs to its May lows just below $30 — cheaper than the first-day price most individual investors would’ve been able to get into, and certainly a discount from its lofty highs.
It’s a tale we see repeated again and again, and investors can learn a thing or two about why this pattern develops, and why it’s destined to continue in future offerings:
Expectations Can Kill
The interest in IPOs often has to do with finding the “next big thing.” However, this naturally means that hype can reach absurd levels, making it nearly impossible for a company to live up to such expectations.
You can easily say this for Twitter stock, as many people believed the company would be the next Facebook (FB).
However, while TWTR certainly qualifies as a “mainstream” service, it doesn’t have nearly the same widespread appeal as Facebook thanks to its rapid-fire nature and extremely short form. Realistically, no one should’ve been surprised by Twitter’s difficulties with user growth.
That doesn’t mean Twitter’s about to explode. But it does mean that expecting TWTR to rightfully enjoy the same valuations of a Facebook was a bit farfetched.
Supply and Demand
When a company executes an IPO, it typically issues a relatively small amount of stock — this helps to pump up price (simple supply and demand).
The Twitter IPO was no different, issuing only 70 million shares of Twitter stock vs. a much more sizable 544.6 million shares outstanding.
But this only created short-term support. A flood of Twitter stock eventually came on the market upon the expiration of several lockups (a lockup prevents insiders from selling their shares) — something we also saw with LinkedIn (LNKD), Yelp (YELP), Pandora (P) … and even Facebook.
Tech Is Tough
Even if an offering falls back to its IPO price (or even below), it doesn’t mean it has become a bargain. This is especially the case in the highly volatile tech world. In many cases, hot companies simply evaporate because of new competition, a failed model or just the fact the company’s business was a fad.
In each of these cases, there were good arguments to be made for buying shares on the first day. After all, there are no clear-cut rules for investing — you’ll always find exceptions.
But the hype cycle of IPOs is a well-worn pattern.
Even if it’s not perfect every time, patience pays off a lot more often than it doesn’t. You’re not guaranteed to buy a winner off the bottom, but at the very least, you’ll keep yourself from buying a dud at the top.
Tom Taulli runs the InvestorPlace blog IPO Playbook. He is also the author of High-Profit IPO Strategies, All About Commodities and All About Short Selling. Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.