Okay, that headline might be a little much. But I’ve been reading a number of articles in recent days about how evil banks and corporations are for allowing their IPOs to be “overpriced”. I believe this is a misinterpretation. The whole point of an IPO is for it to be “overpriced”.
This argument about IPO pricing appears like another case of people misunderstanding primary and secondary markets. As I explained in my piece on the myth of “investment”, primary markets are where companies raise capital for future investment. Secondary markets are where savers allocate their funds into securities that are exchanged. No money goes to the company on a secondary market. From a pure economics perspective, you are not investing in secondary markets. You are just allocating your savings in securities tied to the corporation’s performance. It’s not unlike opening a savings account where the bank buys very safe short duration securities. You wouldn’t call this an “investing account”, would you? Of course not. That would imply a level of risk that might make you feel unsafe. Wall Street does the same thing with “investing” which is supposed to be synonymous with “get rich”. You get the picture. It’s word games and we’ve all swallowed it up…hook, line and sinker.
But the whole point of an IPO is to overprice the offering. Granted, I am using “overpriced” rather loosely here, but what I mean is that it is the goal of the corporation (and its underwriters) to sell you as much stock as possible. The entire purpose of the IPO is to raise as much capital as possible. They are not doing the market some grand favor. The company is not trying to get you a sweetheart deal so you can flip the stock 30 minutes later at a higher price. The corporation is being greedy. It is trying to sell you as much stock as you’re willing to buy as long as you’re willing to fork over the cash that will result in them being able to leverage up their operation so they can multiply profits.
You see, corporations don’t have 30 minute trading timeframes. Despite their somber commentary after the fact, the company does not care that you lost money buying their shares 3 months ago. Why? Because the company did not raise capital so it could survive for 3 months. It raised capital so it could survive for 30 years or 30 lifetimes. If you’re a trader who got burned in a recent IPO because you thought Wall Street was throwing you a fat pitch then you’ve misinterpreted the entire purpose of primary markets. Even more so, you’ve misinterpreted the profit motive of the capitalists running the IPO.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.