Transitional system gap
Diminishing of return
Nature of the low and high and estimating the attacking
social sentiments
The need to keep up with the momentum
 
 

He and a growing number of small investors are using a money-making method that until recently excluded people like them in favor of much larger investors, a method that even Browning expects will vanish sometime soon.

"I'm not so sure I can make a living doing this," Browning said, from his office in his Allentown, Pa., home, clad in sweatpants and a T-shirt, his dog curled up at his feet. "I don't know how much longer this market is going to exist." Even now, he makes far less than he used to.

So far in 1999, though, an extraordinarily buoyant market for new stocks has made trading them an easy way to make a modest amount of money. In November, companies raised almost twice as much, $16.9 billion, through first-time sales of stock as in any other month, according to Thomson Financial Securities Data. The average gain in the first day of trading for initial public offerings in November was also the highest ever, at 102 percent.

The 501 initial public offerings, or I.P.O.'s, this year have jumped an average of 62 percent on their first day of trading, more than three times the first-day gain in any other year in the 1990's. A dozen quadrupled and 22 more tripled in the first day from the prices at which they were offered to investors.

For stocks to appreciate that quickly, the shares have to change hands rapidly, with some being bought and sold several times a day. That is hardly the sort of buy-and-hold investing that many market experts like Byron Wien recommend for most investors. "These people just rent the stocks, they don't own them," said Wien, who is the chief United States strategist at Morgan Stanley Dean Witter.

Such startling immediate returns have attracted the attention of individual investors, who now clamor for, and get, a piece of the action and often resell, or flip, the shares they buy within days, even hours. While company insiders are usually barred from selling newly issued shares for a certain period -- often six months -- outsiders face no such restriction.

So great is the demand that services have sprung up to keep investors posted on the latest news about public offerings and established brokerage firms are changing their businesses to cater to people who want to use computers to actively trade these and other stocks.

Wednesday, Merrill Lynch introduced an online trading service that promises investors a chance to buy new shares, but officials of the firm said they were still trying to decide how to deal with customers who flip them, a practice the firm has traditionally frowned upon.

Other firms, like Charles Schwab, are trying to find ways to get more shares of newly public companies into the hands of small investors before the stocks start trading.

Browning has bought and sold 20 new offerings this year, never holding one longer than three weeks, through eight online trading accounts at four different brokerage firms.

All that flipping has brought Browning a profit before taxes of more than $30,000, he said, adding that he has made at least $10,000 more this year trading other stocks. The sum falls well short of the $80,000 he earned at his old job, a salary he has found difficult to replace in the Allentown area.

But Browning said he had lost money on only three new offerings he had been able to participate in. Using two computers to monitor the I.P.O. sections of the World Wide Web sites of E*Trade Group and three other online brokerage firms, Browning vies with thousands of others, usually in electronic lotteries, for as few as 100 shares at a time.

E*Trade and other members of a new breed of electronic brokerage firms, including Wit Capital Group and FBR.com, use these small allotments of I.P.O.'s as enticements to customers. Old-line investment banks have begun to include these upstart firms in distribution of new issues to whet the appetites of individual investors for the stocks they underwrite; the underwriters have also opened up the offerings because managers of some of their client corporations, especially Internet-based companies, insist on making some shares available to investors electronically.

Executives of young companies have also come to regard a big first-day jump in the price of their stock as an invaluable promotional event, even though such run-ups suggest that the company could have sold its stock for much more money.

On various electronic message boards and chat rooms dedicated to stock trading, dozens of speculators can be seen exchanging information and strategies for getting shares of companies poised to go public. At least two services have been created this year to cater to these online speculators, offering to alert them instantly to the latest opportunities for a monthly fee.

Richard Mehta, an investor in Sunnyvale, Calif., estimates that at least 200,000 people are trading initial offerings electronically. He is trying to capitalize on the strong demand by selling a service, eWebWatch, that notifies people, by e-mail message, telephone or beeper, as soon as one of four online brokerage firms posts new information about a planned offering. In two months, more than 200 people have agreed to pay $6 to $9 a month for the service, Mehta said.

"I could see it in my circle of friends," Mehta said. "None of them were into I.P.O. trading, and then, in the last couple of months, six or eight of them are into it."

Investors are drawn by two beliefs, he said. The first is that shares of new stock are inexpensive; the second, and more important, is that they are as close to a sure thing as an investor can find.

"People think there is a very minimal risk in buying 100 shares at $10," Mehta said. "That's the logic people use in the I.P.O. market: 'Hey, I have nothing to lose.' "

What they have to lose, of course, is whatever they invest; stocks can lose their entire value. Wien of Morgan Stanley Dean Witter said that the current mania reminded him of the late 1960's, when a booming market for new stocks and stocks of small companies culminated in a long market downturn.

"Right now, it seems like a sure thing and sure things sometimes continue for a while," Wien said. "But they don't last forever."

Still, the view that prices of brand-new stocks are more likely to rise than fall is not groundless. In fact, that is how investment bankers on Wall Street designed the process.

Traditionally, underwriters tried to determine what mutual fund managers and other big investors thought a company was worth, then priced its shares 15 percent or 20 percent lower. The strategy was to set the stock up to "pop" higher in its first day of trading, a rise expected to make company executives and their new shareholders happy and to create demand for future stock sales.

Stockbrokers distributed shares to their best customers, treating them as a perquisite that should be tucked away, not quickly resold. For individual investors, flipping new shares was a no-no. Brokers made it clear that investors who repeatedly flipped were unlikely to get more.

To reinforce that policy, big brokerage firms have in some instances refused to pay commissions to brokers for selling shares of initial offerings if their clients resell the shares too soon.

For example, last month Merrill brokers learned that they would be penalized, through the loss of commissions, if their customers were deemed to have flipped shares of TC Pipelines L.P., a Canadian oil-pipeline partnership. The stock, which went public on May 28 for $20.50 a share, barely rose above its offering price before sliding downward, closing Wednesday at $16.

Even Merrill cannot exert that degree of control in dealing with online investors. One feature of Merrill's new online service is access to initial offerings the firm underwrites. Sometime next year, Merrill plans to start holding lotteries that will give online investors a chance to buy 100 shares of I.P.O.'s.

"As of now, we don't plan to place any restrictions on when and how you sell" any shares of an initial public offering bought through an online lottery, said Madeline Weinstein, a senior vice president at Merrill. But, she said, that plan could change if the firm's brokers object. "This is an issue for us."

Even firms that have been built in recent years around the idea of changing the ways of Wall Street are grappling with how to deal with I.P.O. fever. Ron Readmond, co-chief executive of Wit Capital in New York, said that the firm has a policy of penalizing customers who buy shares in new public offerings but do not hold them for at least 60 days. But, he admitted, because of the complicated process of taking orders for I.P.O.'s, some investors do manage to get in on them shortly after flipping others.

Brokerage executives also find it harder to argue that flipping is harmful or irrational in the current market environment. Few of them will criticize an investor for selling a stock for $50 a share on the same day it was bought for $20.

"In a more rational world, stocks don't come out at 20 bucks and go to 50 bucks," said David Pottruck, co-chief executive of Schwab in San Francisco. Schwab has teamed with two electronic brokerage firms to create an online investment bank that hopes to distribute as much as half of the shares in the initial offerings it underwrites to individual investors, compared with the usual allocation of 20 percent to 30 percent.

Readmond thinks that the electronic revolution in the financial markets will lead within 18 months to a 50-50 split of new public shares between individual and institutional investors. When that happens, he said, the initial gains in those stocks will start to subside, as underwriters learn to gauge better how individual investors will react.

In the meantime, traders like Browning say they will continue to try to exploit the cracks in the system that let them profit handsomely from new stock offerings. Browning has had online debates with other I.P.O. traders who support no-flipping rules as a needed damper on the volatility of new-stock prices.

"Personally, I don't have a problem with flipping," Browning, who is 43, said. "I'm providing the company that's doing the offering with the capital they want. What I do with the stock thereafter should be of no concern to them."

Despite the success he said he had had trading I.P.O.'s, Browning acknowledged that in most cases, he would have done even better if he had held the stocks longer.

Take his experience with Red Hat Inc., a software maker. Browning said he sold 100 shares of Red Hat for $43 each, or a total of $4,300, in their first day of trading in August. That gave him a pretax gain, after commissions, of $2,805.

Not bad. But if he had held those shares through Wednesday's trading on the Nasdaq stock market, they would be worth more than $21,000.