What Does IPO Stock Investment Mean?
After the Initial Public Offering (IPO) of a company, a specific number of shares of the company are released into the secondary stock market.
The investors, along with their registered broker, can buy these IPO stocks as an investment option.
This IPO stock investment provides the opportunity for an investor to share the dividend and profits that the company makes over time. In contrast, it may also lead to losses if the company takes a downturn.
Thus, every investor needs to be aware of the pros and cons of buying IPO stocks. Furthermore, investors should consider a number of vital parameters before choosing an IPO stock to invest.
How do Investors Choose IPO?
Since IPO do not guarantee the investors double or triple returns always, it is wise to follow the mentioned steps to choose the right IPO stocks.
1. Conduct In-Depth Research About The Company
An initial public offering (IPO) is initiated by a company when the company aims to raise fund from the public. As an investor, you should conduct a research about the company to understand the objective of IPO.
Is the company raising capital for growth and expansion? The investor should follow up the news related to the company to understand the motive of the IPO.
You should check the performance of the company in the last years to predict if the company performance had a growth or decline in the previous few years.
Therefore, the investor should keep an eye on the company performance, past press releases, its competitors and its position in the industry to judge if the IPO stocks are worth the investment.
In addition, you may look for more information about the company online. Perhaps, you may find blogs that may influence your decision about buying the IPO stocks.
2. Read Through the Prospectus
The company prospectus can provide an outline of the financial position of the company. Thus, it is essential for an investor to study the prospectus thoroughly before buying an IPO stock.
The entrance timing of the company into the market, its strategy of growth and the success path are clearly described in the prospectus. Thus, an investor should read it to make an informed decision.
Moreover, the investor gets a clear idea about the fundamentals of the company that determines if he should buy the IPO stocks or not.
However, in most cases, the company prospectus is biased and discloses partial information.
3. Check the Underwriters
Underwriters are generally investment banks that take legal responsibility for the sale of IPO stocks at a high profit. Underwriters decide the price of each share after the valuation of the company.
It has been observed that an IPO stock undertaken by strong underwriters had successful manifold growth in the long run. Thus, the investor should learn about the underwriters before investing in IPO stocks.
The small underwriters offer individual investors to buy pre-IPO shares owing to the small client base. But the investor should be cautious while dealing with a small brokerage.
In the case of a large brokerage, an individual investor won’t be allowed to make his first investment on IPO stocks. They hold on IPO stocks for established and high net-worth customers.
However, a significant investment bank does not assure a profitable IPO. Thus, the investor should check the reputation of the underwriters.
4. Wait for Lock up Period
The lock up period is the legal binding that restricts the insiders of the company to sell their share. It generally extends from 3 to 12 month.
After the lock up period ends, the investors should notice if the initial investors are selling their personal shares or holding onto it.
Holding the shares would infer that the company is sustainable and may have grown in the near future while the sale of those personal stocks would indicate a red flag for the investors.
Therefore, waiting until the lock up period may be an excellent strategy to understand the worth of the company. The investors would get a clear idea of whether to invest in the company.
5. Check on Debts of the Company
Since IPO is a money-making exercise for the company, some companies release IPO stocks to clear off its debts.
Therefore, in such cases, the company is expected to exhibit a deep downturn soon after the IPO.
The investor should check if the company going public have any debts. If any debt record is found, the investor should evaluate the debt with capital to be raised by IPO.
Moreover, you should check on the indebtedness of the promoter of IPO as well. The investor should check the background and experience of the promoter to analyze the worth of an IPO.
Therefore, checking on the debts of the company and promoter stands as a vital parameter for choosing an IPO stock.
6. Be Skeptical
Private companies do not disclose financial statement and strategies to the public. Thus, at the advent of an IPO, there is a lack of substantial information in the market.
Therefore, the investors should exercise skepticism in the IPO market. You should cautiously deal with an IPO, especially if a broker recommends it.
In most cases, if a broker is strongly pitching about an IPO, there is a high chance that there is a vast number of unsold IPO.
Furthermore, a broker often recommends higher allocation for their ‘big clients’. If the broker does not consider you into that category, be cautious about investing in that IPO.
Skepticism can save you from a bad investment in an IPO.
Conclusion
An IPO has its own unique risks that make it stand out from other stocks. Thus, investors should choose an IPO cautiously.
Moreover, competition does not end here. After selecting IPO stock, you have to bid for it.
Bidding at a cut off rate is beneficial for investors. After you have bidden successfully, the IPO stocks are finally allocated.
After allocation, wait for a few years to observe the performance of the company.
There are two possibilities during this stage. First, the company performs well, and the investors can enjoy dividends or sell the shares at a profit. Second, the company takes a deep downturn, and the investors lose their money.
In order to avoid the second consequence, it is essential to choose an IPO wisely. As an investor, you should follow the given tips to select the right IPO stocks.
