The MUSCLE Method _®

Watch the Early Trading

Now comes the fun part. You’ve analyzed an IPO, you like the story, and you’re ready to buy it. You likely won’t get shares at the offer price, but that gives you one last piece of information to digest: Early Trading. It’s the ultimate indicator of demand.

First look at where the IPO prices compared to the original range.

If investors are willing to pay more for shares, management may raise the price so that they don’t leave money on the table. If the IPO prices at the high end or above the range, that’s an indication of strong demand. Pricing near the midpoint of the range is healthy and normal. Pricing at the low end or below the range is a warning sign. Either demand is low, or investors are pushing back on valuation.

One caveat: Sometimes a strong business in a boring sector receives little initial interest, and comes public at an attractive valuation. It can turn out to be a great long-term investment. A hot IPO can also price too high and then fall hard (this is less common).

A company may also raise or lower the proposed IPO price range a few days before the offering. Again, a raised range signals strong demand and positive early trading. A lowered range means the opposite.

Know what you’re getting into, and check the IPO return.

How was first-day performance? Where did it go from there? While big pops on day one are fun to watch, they aren’t always indicative of future performance. A broken IPO however is often hard to come back from. A first-day return of 10% or more is generally a strong debut. It’s weak when an IPO “breaks” or trades below its IPO price.

Most investors get their shares in the aftermarket.

It is very difficult to get shares of an IPO at its offer price, but money can be made in the aftermarket. Aftermarket return is the IPO’s performance since the end of the first day of trading. This is where most people get shares. For that reason, it is worth keeping an eye on performance excluding the first day.

Strong aftermarket trading is about 7% or higher than the first day close. Be wary of IPOs that are below their first day close and trending downward. Often companies with high pops need to settle back into a price that reflects their true value.