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Should you invest in an Initial Public Offering?

manwithphone19160846.jpgFor the novice or uneducated an Initial Public Offering (IPO) is when a stock is first introduced as a publicly traded commodity. These tend to be "hot investments".The reason for this is simple-investors are people.Most people like novelty and get excited by something new, especially if it holds the promise of making them a whole lot richer and provides bragging rights at their next party. This can explain why both amateur and professional investors alike tend to lose their minds in bull markets, particularly when a hot initial public offering, or IPO, is offered to them by their broker.

On the other hand if you had been lucky and smart enough to havebought into the initial public offering of many of the most recognizable companies today you may have had some volatile price fluctuations along the way, but there is no question that you would have made enough money to substantially change the quality of your life. There is plenty of evidence to clearly show that a well chosen IPO investment can be a life changing experience if you simply make the right choice and stick the stock certificates in your safety deposit box for thirty years. On the other hand there are as many companies that left investors with total losses and drained their portfolios of precious capital that could have compounded into huge nest eggs if given enough time.

So the question remains-Should you consider investing in Initial Public Offerings?

Many experienced and well-known financial experts continue to recommend that investors steer clear of all initial public offerings. The reason for this is that during an IPO, the previous owners are attempting to raise capital for expanding the business, cash out their interest for estate planning, or any other myriad of reasons that all result in one thing-a premium price that offers little chance for buying your stake at a discount. IN addition there can be even just a small bump in the business that will cause the stock price to collapse within a few years, giving the value minded investor an opportunity to load up on the company he or she admires.

However the problem comes from the fact that if you find a truly outstanding business (one that you have conviction will continue to compound for decades at rates many times that of the general market), even a high price can be a bargain. The bottom line is that it becomes extremely difficult to sort out the chaff from the wheat, so you are probably going to do better by sticking to your guns. In theory, this position is one of conservative and disciplined safety. It ensures that you will not get burned and the average investor will likely be well served in the long-run by adhering to that principle.However if you insist upon risking your capital, you should ask yourself a few key questions:

  • If this business does not grow at a high enough rate to justify its price, what is the likely cause? What are the probabilities of these failures occurring?

  • What are the competitive moats that will protect the company? These may include patents, trademarks or even key executives.

  • Would you feel comfortable owning this business if the stock market were to close for the next twenty years? Is this business model and the company's financial foundation sustainable or is its possible failure a result of technological advancement or lack of sufficient capital a possibility?

  • If the stock falls by fifty percent due to short term problems in the business, will I be able to continue holding without any emotional response if I determine that the long-term potential of the business still remains promising? In other words what is my capacity for risk?

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