New IPO stocks typically come to market when it’s a good time for insiders or the company to sell. That isn’t necessarily a good time for you to buy. Often, it’s a good time to stay out.

Natural human inclinations turn up in all sorts of commercial transactions, and they operate as a filtering mechanism. As we’ve often written, they similarly skew the odds against you when you enter the market for various kinds of investments.

One of these is the market for new IPO stocks. You can get lucky in the new-issues market, just as you can in the used-car market, or in a lottery. But the odds are against you. Here, too, there’s a filtering mechanism at work.

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New IPO stocks, or new issues, typically enter the market when it’s good for the company insiders to sell

New issues typically come to market when it’s a good time for insiders or the company to sell. That isn’t necessarily a good time for you to buy. Often, it’s a good time to stay out.

On those out-of-the ordinary occasions that a new issue comes to market when it’s a good time for you to buy, then you probably won’t be able to buy much if any, at least at the new-issue price. That’s because the underwriters know when they have a “hot new issue” in the pipeline—that is, one whose share price is likely to shoot up as soon as public trading begins. In that case, they reserve most of the shares available at the initial new-issue price for their biggest and best clients.

If you’re not in that favoured group, you’ll have to buy in the after-market, after prices have moved up and the favoured buyers are taking profits.

With new issues, the best rule for conservative, risk-averse investors is to wait till they’ve gone through an industry setback, if not a full-blown recession. By then you’ll know if they’ve matured into high-quality stocks, or joined the ranks of played-out speculations.

We look at a lot of new or recent new issues, and mostly decline to get involved. Every now and then, we do recommend one, but without illusions. Sometimes these recommendations pay off, on occasion spectacularly. But they succeed with less regularity than our recommendations of the well-established, profitable, mainly dividend-paying companies we focus on.

Beware of brokers offering new IPO stocks; An awareness of their motives could save you money

Brokers reserve their best new issues for their biggest and most co-operative clients—those who do a lot of trading, or who buy every new issue the broker offers them.

If you rarely buy new issues, you will rarely if ever be able to buy a significant portion of the best new issues. Brokers know how attractive IPO investing is to clients. With all the hype, investors are eager to buy these particular types of investments. Brokers make greater efforts to cash in on that demand by bringing more of the investment to market. That means the average quality of new issues in popular market areas tends to go down while prices get bid up, sometimes to ridiculous heights. There are exceptions, of course. But this combination of rising prices and falling investment quality leads to bad deals for investors.

Even with attractive new issues, it’s best to stay out of them. If a new issue has genuine long-term investment appeal, it will be an attractive buy for months or years after it reaches the market. A good practice for investors interested in IPO investing is to set up a watchlist of new IPO stocks they are interested in at the time. After six months to a year, check back to see how these IPOs performed. You may be surprised at what you find. This would be the time to re-evaluate the stock to see if it has a place in your portfolio.

An exception to our rule on new IPO stocks

IPOs are more attractive and often easier to obtain when they are part of a privatization effort—when a government sells a government-owned enterprise to investors.

With privatization, governments often price an IPO at an attractive level that almost ensures that buyers will make money. That’s because governments are less concerned than a private seller would be about getting a good price in a privatization. Instead, they are more concerned about maintaining the goodwill of buyers, for political reasons. Rather than try to get the best price, they may sell a privatization at a good price to a wide range of individual buyers, to win goodwill and votes in the next election.

Use our three-part Successful Investor approach for all investing decisions, especially when looking at new IPO stocks

1. Invest mainly in well-established, dividend-paying companies, with a history of rising sales if not earnings and dividends.
2. Spread your money out across most if not all of the five main economic sectors: Manufacturing & Industry; Resources & Commodities; Consumer; Finance; Utilities.
3. Downplay or avoid stocks in the broker/media limelight. When stocks spend time in the limelight, they tend to become overpriced, and this leaves them vulnerable to a sharp downturn on any hint of bad news. Instead, look for stocks with hidden value that are less widely recognized—at least so far—as attractive investments.

Some IPOs have reignited debates on dual-class shares and whether or not they should be limited or banned. What are your beliefs about the fairness behind dual-class shares?

For most investors, IPOs are a risky investment. What would you suggest to young investors interested in IPOs?