NEW YORK -- Small investors tempted by red-hot initial public stock offerings better watch out before they get burned.
High-flying IPOs, which shoot to the skies when the gates open and allow some investors to make a killing, are the exception in a risky game.
Studies find IPOs -- even some of those that generate the most excitement -- underperform the market or lose value after the early euphoria.
"The general point that I would make is: Don't invest any money that you can't afford to lose," says Jay Ritter, a finance professor at the University of Florida who has studied the dangers of IPOs.
An IPO is the first sale of common stock by a private company. It doesn't stand for incredible profits overnight as some people with delusions might want to believe.
The bull market of the 1990s and investors' fascination with Internet companies, such as Broadcast.com, has fueled one of the biggest IPO booms. The recent downturn on Wall Street, however, is likely to reduce the fever.
In the past eight months, more than 301 companies have gone public with deals worth $22.5 billion. The IPO volume outpaces the $20.8 billion raised by 355 companies during the same period last year.
Normally, IPOs purchasers tend to be big investors such as money managers and pension funds. But investment banks are now making new issues available to discount brokers like Fidelity Investments, Charles Schwab & Co. and E-Trade, all of which cater to individuals.
If you're one of those individuals captivated by all the publicity surrounding the hot deals and with the opportunity to get piece of an IPO, consider this before attempting to throw your money into the pot:
In the past three decades, hot IPOs, which at least doubled after the first day, were outnumbered 3-to-1 by new issues that lost money, according to a recent review by Securities Data Co.
Mr. Ritter, of the University of Florida, has more sobering statistics. He says only one in every 100 IPOs double on the first day. About 25 percent give a zero or negative return.
That means for every Broadcast.com, which shot up 248 percent on July 17 in the hottest initial offering, there are many IPOs that sink like lead from the start or becoming sour in the long haul.
A prime example is Boston Chicken -- one of the 10 hottest deals ever. Its shares jumped from an initial offering price of $20 to $48 on the first day on Nov. 8, 1993. Today, those shares are worth less than $2.
"The main problem for individuals is that it's a lot easier to get their hands on those that do not go up than it is to get their hands on the Broadcast.coms of the world," Mr. Ritter says.
Most brokers would quickly push the less appealing IPOs -- probably destined for failure -- that they can't get their elite clients to buy.
But even if you do get piece of a hot deal, warns Stan Feldman, a finance professor at Bently College in Waltham, Mass., your broker may discourage you from selling, or "flipping," your shares quickly to cash in on any initial runup.
Flipping usually presents investors with the greatest opportunity to make money on IPOs because prices soar initially but may falter in the long run. "If you have the opportunity to sell after the initial runup you could do well," Mr. Feldman says.
Numerous academic studies, including a new one that's being prepared by Mr. Ritter, of University of Florida, have found the long-run performance of IPOs is dismal.
Mr. Ritter found the average return on new issues between 1993 and 1998 that at least doubled the first day was 10.9 percent compared to a return of 60 percent for the broader stock market.
In a review of 4,500 IPOs in the 1990s, Mr. Ritter found the majority fell below the offering price after five years. A more recent study by data provider CommScan also found many hot IPOs grow cold in the first year.
"In most cases you would be better off investing in a diversified portfolio of stocks rather that putting your money in an IPO," says Mr. Feldman. "IPOs are like options -- sometimes they expire valueless and sometimes they go through the roof."