For the past several months, a close friend of mine has been salivating about the upcoming IPO of VMware (NYSE: VMW). He thought that it would be a great investment opportunity. He even tried, unsucessfully, to get some shares at the IPO. VMware finally went public earlier this month in a wildly successful offering. Turns out that my friend was right. The IPO was an excellent investment opportunity. My friend invested at $55 a share, so as of Friday evening his investment certainly paid off (the stock closed at $71.30).
However, not all IPOs have a happy ending. In fact, a number of academic studies have shown that for the first 3 to 5 years after an IPO, shares of newly public companies tend to underperform the general market. See for example this article, and this excerpt. This is such a well known phenomenon that I first heard about it when I took my very first finance class in business school.
My friend did very well for himself, but I am not clamouring for a share of that pie. In fact, I am going to stick to my tried and true indexing strategy and not try to outperform the general market. While my friend seems to have beat the odds so far, on average he is playing a game that is stacked against him. Remember, some people also win money at the slot machines, at the roulette table or by playing their state lottery, but that doesn't mean that playing those games is a prudent investment strategy.
Thanks for the offer, but I'll take my equity investments slow, steady and well diversified.