With next week's Twitter initial public offering (IPO), you might be wondering if you should buy some stock.
Gary E.D. Alt is co-founder of Monterey Private Wealth.
But for naïve investorS, their primary consideration is the hope that they'll make a quick buck if the stock price surges on the first day of trading. For them, the results could be disappointing or even disastrous.
Those who'll profit most from Twitter's IPO are early investors and employees. For everyone else, including you and me, the chance of making a short-term profit is very risky. Speculation is always high-risk, making it unsuitable for a wise investor.
Here are five important factors to consider before jumping into any IPO, including Twitter:
1. There's no guarantee that you'll profit at all. Sure, the big winners make lots of headlines but in reality there are a lot of losers. Of 132 IPO's in 2012, over 40% of them were trading below their offering price at the end of the year, according to 123jump.com. The worst performer, CafePress, is still down over 68% today. Do you have the stomach for this type of risk?
2. Going public is a tough transition for management. Tech startup entrepreneurs are good at bootstrapping a business in their basement or garage, chasing their wild ideas, and refining them while others think they're crazy. When the company goes public, suddenly there are lots of rules and regulations to deal with. Then there's the fun of dealing with finicky stock analysts. There's no more shooting from the hip -- Wall Street doesn't reward gunslingers. Andrew Mason, founder of Groupon, was booted from the company last February after several quarters of earnings fell short of expectations.
3. How does this investment fit into your overall wealth management strategy? Investing in IPO's can be a wild ride. The IPOX-100 US index has been 24 percent more volatile than the S&P 500 over the past 3 years, and individual companies can be a lot more volatile. What does the rest of your portfolio look like? Do you really want this added volatility?
4. Is this a company you want to own for the long-run? This is one of the more important factors that's commonly ignored. When you buy a stock, you're buying a company. Whether you're an investor or an entrepreneur, you'd never buy a company without knowing how it makes money and what the business risks are. Start by thoroughly reading its S-1 filing, the official registration of securities with the Securities and Exchange Commission.
5. How and when will you buy the shares? Unless you're affiliated with the company or the underwriter, there are only two ways to buy the stock; either buying on the open market when it begins trading or getting some of the limited number of shares available through your financial advisor. If you buy on the open market it'll be even tougher to make money if the stock price soars because you'll be buying at a lofty price. If you can get shares from your advisor you can buy at the offering price, but shares are very limited making them difficult if not impossible to get. Buying on the open market may be your only option. Sometimes it's even better to wait for a price drop.
If you're going to invest in IPO's, consider all of these points - don't jump in just to make a quick buck. Risk management is the most important step in an overall wealth management strategy. There's a lot of hype that goes along with high-profile IPO's like Twitter -- don't let the hype throw you off your long-term strategy.
Gary E.D. Alt is co-founder of Monterey Private Wealth in California and can be reached at www.MontereyPrivateWealth.com