A hot initial public offering can generate media coverage and excitement as a promising company offers its shares for public trading for the first time. The problem with the hottest IPOs, however, is that they usually are made available to the largest institutions on Wall Street first. Everyone else is forced to wait for trading to begin to buy shares.
The Road to the IPO
When a company is ready to sell shares to the public for the first time, it hires a group of investment bankers and broker dealers to find buyers for the shares. Referred to as underwriting, each member of the group generally allocates shares to its largest investors, which usually consists of other investment banks, hedge funds, pension funds, and institutional investors. Hot IPOs tend to sell quickly, with buyers placing orders for more shares than are being offered. Referred to as an oversubscribed IPO, its shares are sold out long before being made available to smaller investors. In these situations, the first chance for investors to buy shares is at the open of trading.
The shares of hot IPOs can open for trading at a substantially higher level than the offering price. For example, Alibaba shares were offered to IPO investors at $68. The shares opened for trading at $92.70.
Buy the Owners
There is a way to participate in IPOs without buying the shares directly, by purchasing the shares of companies that have established substantial ownership stakes in a company prior to an IPO, or mutual funds with a stake in those companies. For example, Alibaba's IPO was oversubscribed during the underwriting period, with all the shares in the offering going to a select group of large investors. Years before the IPO, Alibaba had accepted substantial investments from Softbank and Yahoo. Softbank's stake represented an ownership stake in Alibaba of 37 percent, while Yahoo owned 24 percent. Due in part to their ownership stakes, both companies started appreciating months before the IPO. By January 2015, four months after the IPO, Yahoo's investment in Alibaba represented 85 percent of its total market cap.
Smaller IPOs can be made available through regional brokerages, online brokers and mid-sized investment banks, which may allow individual investors to buy shares in the offering. In these offerings, the minimum investment is set by each institution that is offering shares. The risk of these offerings is that they usually aren't supported by the large institutions that get involved with the headline-making IPOs. Without that support, smaller IPOs are usually released without the kind of hype generated by massive media coverage. If IPO shares are made available, do some research on the company before making a purchase to see if it is fundamentally strong. If not, the purpose of the offering may be to allow insiders to lighten up on their share ownership.