A lot of people are asking me about the Twitter IPO. Should I buy shares in the social media company when they are issued later this month, they ask. And, the answer is simple: Not if you were planning on buying the first day it's issued.
· You're not likely to get in at a good price. The typical trajectory for a high-profile company like Twitter coming to market for the first time is that the stock runs up almost immediately. The pros are engaging in what they experts call "price discovery." Why should you care? Because the stock can trade lower after the initial euphoria wears off – and that means you may lock in your shares at a high.
· The IPO isn't for you. Floating public shares is a way for insiders to cash out and for the best clients of the Wall Street banks backing the deal to lock in profits. Flipping the stock, holding it just long enough to reap the rewards of the initial run-up is common. It's the "greater fool" theory: Bankers and insiders are relying on individual investors to help prop up the prices.
· Being well-known, which Twitter is, isn't the same as making money, which Twitter isn't. Or rather it's not making profits. In its filing with the Securities and Exchange Commission, the company revealed the good news that it's revenue more than doubled to $254 million in the first six months of the year, but also the bad news, that its net loss grew by 40 percent to $69 million. User growth is slowing and so are the prices it charges for advertising, its main source of revenue.
· Not buying on the first day doesn't mean you never buy the stock. Smart IPO investors wait to see how the company is valued and buy after the hot money is out. In other words, they do their homework and make sure they understand the business.
In sum, I'm not saying that Twitter is a bad company. In fact, I am a huge fan and use it nearly every day of the week. The point I am making is that it can be difficult for individual investors to profit from IPOs. Plenty of small investors got burned in the Facebook IPO in May 2012 when the social media company's launch onto the stock market was marred by technical glitches that prevented or delayed orders from going through. It's not likely that a Twitter IPO will have the same problems, but the Facebook debacle should be a warning for all small investors when it comes to red hot IPOs.