By John Wasik
CHICAGO, Nov. 4 As the founders and backers of
Twitter move toward the ultimate tweet - an initial
public offering - it's a good time to ask whether IPOs are good
Can the hot social media buzz surrounding Twitter be
sustained for the company to survive a flame-out? While few can
accurately predict future earnings growth, management decisions
and whether the service can grow and gain more popularity, it's
good to cast a cautious eye on IPOs in general and cast a wider
Keep in mind that Main Street and Wall Street investors may
have entirely different takes on IPOs. Short-term traders may
"flip" the stock after a few days - or even hours - and then
move on. Individual investors may be gun-shy about owning IPOs
after last year's botched offering of Facebook. It took a
year for investors to recover from the company's initial price
If you like small- or micro-cap companies for their growth
potential, it would make sense to own a passive index of them.
The iShares Micro-Cap ETF, for example, tracks the
Russell Microcap Index, charging 0.72 percent for annual
expenses. The fund is up nearly 37 percent for the year through
Nov. 1 and holds companies like Methode Electronics,
Multimedia Games Holding and Boulder Brands,.
For a much-broader based fund that holds small companies
throughout the world, consider the SPDR S&P International
Small-Cap ETF, which has gained 22 percent for the year
through Nov. 1. The fund charges 0.59 percent for annual
expenses and holds companies like Belimo Holding AG,,
Shochiku Co and Rubis.
As with IPOs in general, although small-cap ETFs spread out
the risk among hundreds of stocks, they are still much more
volatile than their large-cap brethren. A fund like the iShares
Microcap, for example, carries of five-year standard deviation -
a measure of volatility - of 23, compared with 16 for the S&P
LONG-TERM RECORD TROUBLING
How well you can do with an IPO depends upon how long you
hold it. The timing involved in selling it, though, can be
Over the short term, when investor excitement is high and
the general investment climate stable, IPOs can produce some
startling initial gains. When Netscape, one of the first
Internet browser companies, went public in 1995, the offering
price was $28. The stock soared to $174 by the end of that year.
But as the competition dug in, Netscape's market share
cratered from 80 percent to less than 10 percent. By 2008, the
company, long since absorbed by AOL, was pretty much
kaput as a serious browser business. Countless IPOs have
followed the same course, so it's wise to avoid wagering a big
stake on an offering and instead choose a broad-basket index of
What makes an IPO successful - at least in the short-term -
is widespread optimism throughout the market and in the sector
the stock represents. Internet stocks went gangbusters up until
the dot-com bust of 2001. Are social media stocks headed for the
"IPOs can be a good investment, but usually they don't work
out long-term relative to the market," says David Zuckerman, a
certified financial planner in Los Angeles. "I typically try to
persuade my clients not to buy them."
It helps to look at the sectors of the stocks being offered
this year and try to gauge their long-haul appeal. Overall, it's
been a strong year for IPOs, with 111 companies going public in
the second and third quarters and another 11 going to market in
the last quarter, according to Hoover's IPO Scorecard.
In the fourth quarter, biotech companies will dominate, with
eight companies accounting for 14 percent of total offerings,
followed by six software companies, comprising about 11 percent
of the total offerings. The average value of fourth-quarter
offerings is nearly $400 million, compared with $228 million for
the second quarter.
One concern is that this latest wave of IPOs may be feeding
off a bubble mentality - that is, the enthusiasm for new stocks
may be over-valuing them. But when you look at price-to-book
ratios, measures of a stock's market price to book value, maybe
those fears are overblown.
The technology sector, for example, has a negative 15
price-to-book ratio. That compares with 45 for the overall
healthcare sector, which has been popular this year with the
introduction of the Affordable Care Act exchanges.
A low price-to-book ratio could indicate that a stock or
sector is undervalued relative to the rest of the market.
Although the price-to-book ratio is not a perfect measure of
relative values, it may indicate that biotech stocks may be
overpriced and tech stocks are a bargain.
There's even more risk in concentrating in one stock. It's
nearly impossible to predict the course of stock prices in
general; it's even more difficult to forecast the future of just
one company, no matter how bird-like its appeal.