Some investors regard investing in stocks as "playing the market." In fact, all stocks are not created equal. Each company that issues stocks has a unique history of growth, earnings and paying dividends. Thus, each stock offers a different level of risk as well as reward.
Blue-chip stocks are issued by the world's largest and best-known companies. These companies have established track records, including years of growth in both sales and earnings. Of course, that doesn't mean investing in these stocks presents no risk; every stock experiences volatility. What it does mean is that if held for the long term -- five years or more -- history shows the odds are in your favor that your investment will grow in value.
One of the riskiest stock investments is initial public offerings, or IPOs, as they are frequently called. An IPO is a stock that is being offered to the public for the first time. In many cases, the stock is issued by a newly-established company, which makes the future of the stock very uncertain.
A case in point is Netscape Communications, a company that manufactures software for navigating the Internet. When the stock was issued, it grabbed headlines across the nation. In a single day, the stock, which was offered to institutions at $28 a share, rose to $71 per share -- one of the largest single-day gains ever recorded for a new stock. By the end of the week, however, the stock had fallen to $58 per share.
Because of their risk and volatility, IPOs are unsuitable for many investors. If, however, you are interested in adding this type of investment to your portfolio, here are two tips to keep in mind:
- Do your homework before investing any money. Request a copy of the company's prospectus, and read it carefully. This document will provide the information you need to make an educated decision as to whether or not you should invest.
- If you do invest in an IPO, invest only as much money as you can afford, both financially and psychologically, to lose.
If this sounds a bit harsh, it should. History has not been kind to new companies and the stocks they issue. A 1997 Dunn & Bradstreet study showed that 42 percent of all businesses fail during their first five years. Of those that survive five years, 25 percent fail after six to 10 years, and an additional 33 percent fail after 10 years.
Those seeking to achieve long-term goals, such as providing for a child's college education or securing a comfortable retirement, have achieved much more consistent results by choosing high-quality stock mutual funds and the individual stocks of well-established companies with proven track records of growth in sales, earnings and dividends than those who have chosen more aggressive stock investments such as IPOs.
In short, investing in a quality stock investment is a calculated risk that can offer handsome rewards. Investing in an aggressive stock that has no established history leaves your financial future largely up to chance.
