This bit of Street wisdom came to mind last week, as Facebook went public amid so much fanfare.
The stock eked out a 23-cent gain on its Day 1, to $38.23. This suggests that many professional money managers viewed all the hype as just that. Whatever the long-term prospects of this company — an issue over which reasonable people reasonably disagree — the idea that small-time investors might get rich fast struck the pros as absurd.
It is true that initial public offerings have increasingly become a game for early investors and their Wall Street enablers. Since the 1980s, average first-day gains on new stock issues have risen steadily. According to one 2006 study, the average first-day return on I.P.O.’s in the 1980s was 7 percent. By the mid-1990s, it was 15 percent. In the 1999-2000 dot-com boom, it was 65 percent.
We all know how that last one turned out.
It’s no coincidence that as those averages were rising, individual investors were becoming more enamored with the stock market. The great democratization of the equity market, which began in the 1980s, lured small investors into the game.
A lot of these people got burned. Academics at the Warrington College of Business Administration at the University of Florida recently compiled a list of about 250 companies that doubled — at least — in price on their first trading day. Many quickly fell back to earth.
Going back to 1975, the list provides some of the greatest hits in I.P.O. land. The top 10 first-day gainers all went public in the Internet boom. They included VA Linux, which rose almost 700 percent, to a market capitalization of more than $1 billion, and The Globe.com, which produced a gain of 606 percent on its first day as a public company. Foundry Networks and WebMethods soared more than 500 percent.
Some of the companies on the list have disappeared or have been acquired. Others are still around, to lesser and greater degrees. TheGlobe.com trades at less than a penny a share. VA Linux is now called Geeknet and, as of Friday, had a market value of $94 million.
Why did Facebook get a relatively slow start out of the trading gate? One possibility is that the investment bankers who priced the stock considered the history of private trading in the shares before the offering. Facebook was unusual in this way, Laszlo Birinyi of Birinyi Associates pointed out last week.
“There was trading before the I.P.O., so many investors have some feel, some idea of pricing,” he noted. Most offerings are priced based upon what the company and its bankers guess the stock will fetch.
Indications are that Facebook was bought primarily by individual investors, not institutions. Indeed, institutions that had invested early were big sellers in the I.P.O. To many market veterans, this showed that the smart money was getting out while the getting was good.
With investors still believing the advice of Peter Lynch, the former Fidelity fund manager who told individuals to buy stocks of companies they knew as consumers, it is easy to see why Facebook’s offering resonated with the public. But now comes the hard part: operating as a company that returns its investors’ favors with actual earnings.
