Q: Why do IPOs jump over their IPO price so quickly?
A: Investors are often dazzled by the IPOs that soar on their first day of trading. Twitter is just the latest example of a company that gained in value a few minutes after it started trading.
Why do some initial public offerings gain on their first day? It has to do with the way shares of new companies are sold by the investment banks. The company's shares are first mostly sold to large institutional investors, like mutual funds and clients of the investment bank. The shares are sold to these initial investors at the offering price.
When shares of an IPO are especially in strong demand, investment bankers might underestimate the price. And so, when the stock starts to trade on the exchange, all the other investors are free to rush in and buy. And what happens whenever you have something that's in short supply where the price is free to move? It skyrockets.
Keep in mind not all IPOs jump on their first days of trading. It's pretty common for shares of initial offerings to fall, too. For instance, in November a telecom company called Mavenir sold shares for the first time at the offering price of $10 a share. At the end of the first day of trading, the shares closed down at $9.64. First day gains in IPOs might be getting more common, but they're still not something you can bank on.
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Follow Matt Krantz on Twitter: @mattkrantz.
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