Hardly a day goes by without some notice in the media of investor unrest over their treatment in the stock market. One of the biggest examples followed the initial public offering (IPO) by Facebook that was anticipated for many months, but launched like a lead balloon.
At the end of the day shares of the newly-traded Facebook stock closed at about where they began the day. This was a terrible shock to many investors since they've felt Facebook stock would rise dramatically on the first and future days of trading.
Suspicions quickly turned to the investment banks that underwrote the Facebook IPO and investors and lawmakers began questioning whether there was full disclosure of important information before the stock went on sale.
Investors are supposed to be protected by full disclosure of any and all important information about a company before its stock is traded.
While this sounds comforting, few people in the industry would believe that that's the way things truly happen.
IPOs are all about lining the pockets of investment bankers and their key clients.
These insiders have access to the first shares of stock on an allocation bases. By the time retail investors have an opportunity to buy the stock, it is probably passed through several hands each taking a piece of profit along the way.
There is no objection to people making intelligent investment decisions and profiting from them. IPOs and in particular those they carry a lot of hype before the offering, often stack the deck against retail investors.
This is not to say that eventually stocks that make their initial offering amid much fanfare are bad investments.
The concern is people who expect every stock to rise dramatically after its initial public offering or who were sold shares based on promises of quick returns when no such promises should be made.
The lesson for responsible investors is don't get caught up in the excitement of an initial public offering. It is possible to buy shares of an early stop offering and watch them t rise dramatically, however the experience of many is that this rise often is not sustainable.
If the company was correctly priced at the initial offering, that is, the initial price fairly represented the company's value, there is little reason for investors to pay more.
Yet time and again the hype is too much for people and the excitement of getting in on the ground floor and making a killing often overcomes any rational judgment about the value of the company and the stock price.
If a company goes public through an IPO and is truly a sound, well-managed company there will be many opportunities to buy the stock at a decent price as time goes by.
If the company is offered at a realistic value, investors will have the option to invest again.
It's worth remembering that in terms of stock sold at the time of the initial public offering is the only time that the company pockets any money directly from the sale of stock.
It is in their best interest to raise the stock price as high as they think is practical and maybe a little bit more if there's a great deal of hype around the offering.
If they knowingly overprice the stock, they are potentially cheating initial investors and may in fact be breaking security laws. The best advice for long-term investors is to avoid IPOs and stick with investing in great companies that have been around with a proven track record and will build wealth for you over the years.