Topic: Daily Advice

Investor Toolkit: Why investment success rarely includes new stock issues

Investor Toolkit: New Stock Issues stock image

Every Wednesday, we publish our “Investor Toolkit” series on TSI Network. Whether you’re a new or experienced investor, these weekly updates are designed to give you specific stock market advice that will help you develop a successful approach to investing. Each Investor Toolkit update gives you a fundamental tip and shows you how you can put it into practice right away.

Today’s tip: “There is an element of chance in the success of every business, and it’s rarely worthwhile to test your luck by investing in new issues.”

John D. Rockefeller, founder of the Standard Oil Trust, was one of the richest men in 19th century America. A reporter once asked the secret of business success. John said there were three of them:

  1. Get up early;
  2. Work hard and long;
  3. Above all, be sure to strike oil.

He wasn’t entirely joking. There’s an element of chance in the success or failure of every business, especially when it’s just starting out. This fact has a continuing impact in our approach to investing.

It’s one key reason why we generally stay out of new issues. They tend to be riskier than investors realize, because it’s easy to overlook Rockefeller’s third requirement for success. Of course, new issues also tend to be risky due to what you might call “the selection process”. You can only invest in new issues that come to market. They only come to market when it’s a good time for insiders and the company itself to sell, but that may not be (and often isn’t) a good time for you to buy.

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Facebook’s new issue demonstrates danger of exaggerated expectations

One of the problems with a number of new issues is the excessive hype they receive from what we call the “broker/media limelight.” This causes expectations to be raised to often unrealistic heights—and the fall from those heights can be brutal.

This spring’s IPO by Facebook (symbol FB on Nasdaq) was a classic case of exaggerated expectations turning sour. I advised against buying the stock a week ahead of the new issue (here are my views expressed on YouTube: view the video here). Other well-publicized web-based IPOs have run into similar troubles, such as Groupon (symbol GRPN on Nasdaq), whose shares have lost over 60% of their value since last November’s new issue.

This is why we advise investing mainly in well-established companies. They can go broke, just like start-ups. But it happens much less often, and takes a lot longer. If you invest in well-established companies, you’ll have far fewer portfolio disasters, and those you can’t avoid will mostly be partial rather than total.

This element of chance also explains why we feel so strongly that you should spread your money out across most if not all of the five main economic sectors. The element of risk in the success or failure of every business is partly due to internal factors, particularly management failings. But it also comes from external factors like rising interest rates, trade disagreements or falling product or commodity prices.

If you spread your funds out across the five sectors, you limit your exposure to any one external factor. Then too, outside influences that hurt some of your stocks may help others.

COMMENTS PLEASE—Share your investment knowledge and opinions with fellow members

Most investors find that it’s hard if not impossible to get an allotment of a “hot new issue” that soars after it comes on the market. On the other hand, it’s all too easy to buy the new stock issues that plunge after coming on the market. Has this matched your experience with new stock issues?


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