In order to help you understand what an IPO (initial public offering) is, I’m going to tell you a story. Suppose that I designed a banana that connects to the Internet using coconut shells as antennas. I created a company called Bananasoft, got a patent for the device, and had a few prototypes produced.
I sold the items I had produced, but I had to pay for them with my own funds! Every investor I talked to thought that Bananasoft was worth devel- oping so I decided to look for some investors.
Chimps with lots of money are called venture capitalists. They are always looking for primates with a vision, and that’s me. So they gave me a bunch of money to improve my Internet banana and produce more of them. As soon as the new line of Bananasoft products hit the stores, the
public responded enthusiastically! Everyone loved my products and soon I was raking in the cash.
But I knew that if I had access to even more money, I could expand my business to produce Internet banana accessories, as well as a full line of electronic bug removal devices, which every chimp would own and love.
So my lawyers convinced Central Congo Bancorp (the biggest bank in the jungle) to help me offer an IPO for Bananasoft. In doing this, I sold parts of my company as shares to the public, and I gained even more money to reinvest in research and development as well as production.
The IPO Process Involves Three Steps
First, the private owners of the company must find a bank or brokerage firm to “take the company public” (the bank or brokerage is called the underwriter). In other words, the company doesn’t initially have the means or capital to offer shares to the public all by itself, so the underwriters help it. In my story, Central Congo Bancorp became the underwriter for the IPO of Bananasoft.
In the second step, the underwriters become responsible for the adver- tising, pricing, and legal proceedings of the IPO. They decide on how much stock to offer (this number may range from a few million shares to over a hundred million shares) as well as a price per share they believe to be fair. Normally, it is hard for the general public to buy shares at this point. Shares are offered to company employees, executives, lawyers, underwriters, preferred clients, and anyone else who has a connection to the company. Individual investors usually must file applications and be approved to own shares during this phase.
Finally, as the third step, a date and time are set for the stock to begin trading on an exchange. Bananasoft was lucky. On its first day of trading on the CHMPDAQ exchange, it went from an initial price of $8 to $25.
That’s over 200 percent gain—spectacular! In today’s market, IPOs like this are possible.
But many market monkeys believe that this is the way all IPOs act.
This couldn’t be further from the truth. The thousands of IPOs you don’t hear about may have had mediocre or even poor performance in the initial hours and days of trading. It is very possible that you will lose money trad- ing new stocks!
Chief Chimp Jacob and I both believe that it is important to analyze a stock’s price and trading history before deciding to trade. With no price history, IPOs are on our list of the riskiest trades. Furthermore, in an emotionally charged environment such as the first few trading hours of a new stock, most traders (including even the most experienced old apes)
find themselves letting their stomachs and not their minds control their trades.
In addition to the above dos and don’ts for stock picking, there are var- ious other specific methods that we will teach you. Everything we have told you until now is not nearly as specific as we’d like it to be. If you’re going to be a successful market monkey then you need to be a good strate- gist, knowing which vines to swing from and which to avoid. Once we dis- pose of a few more basics, like picking a stock broker or brokerage firm, we’ll be ready to test the waters of technical analysis as a specific means of picking stocks.
SUMMARY
This chapter taught the basics of stock picking. Here are the basic dos and don’ts of stock picking.
Do:
• Conduct your own research.
• Check The Wall Street Journalor the Financial Timesfor “most active” stocks.
• Find a few other indicators that you think make a stock “hot” and look for them (we’ll discuss indicators later on).
Don’t:
• Be swayed by the charm of the investment guru.
• Buy and sell according to your friends’ and family’s recommendations.
• Listen to other stock “tips.”
When picking stocks and making your investment decisions, remem- ber one thing: Make them on your own. Your friend might be trying to help you in telling you to buy or sell his or her favorite stocks. But your own opinion and research are the most important.
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