An IPO (Initial Public Offering) occurs when a new company decides to raise funds for its future growth.
Once popular brands become publically traded or owned entities, this often gains a lot of media attention. This usually raises the stature and awareness of the company and often piques the interest of potential investors.
Once a company becomes publically traded, it is a noteworthy milestone. This is because it indicates that the company has reached a certain stage in its growth. Once a company can access the public markets it, therefore, has the capital to be able to expand and diversify.
For many investors, it may seem like a good idea to invest in an IPO that is gaining lots of positive attention from the media. The initial share price on newly listed IPOs are often very good value.
However, just because an IPO is garnering positive attention, this does not necessarily mean it’s always a worthwhile investment.
It is essential to consider and understand the common misconceptions about IPOs in addition to the levels of risk versus reward when investing.
If The Media And The Public Seem Enthusiastic About A Certain IPO, Does That Mean It’s A Worthy Investment?
It’s important to bear in mind that even a popular and well-liked company could still turn out to be a poor investment.
We do not recommend investing for the sole reason of its popularity and the amount of popular attention it’s garnering from the media.
This kind of attention can behold extreme valuations could mean that that the risk and reward for this investment are unfavorable at this price point.
Investors should consider that companies who issue an IPO do not have any proven history of operating in the public market. Furthermore, the competitive nature of this landscape has a large effect on the performance of IPOs.
These are some of the many factors to consider that could have a negative impact on the financial outcome of an IPO. Investors should be aware of these issues regarding IPOs before they come to make a decision.
Do IPOs Yield Higher Returns Rather Than Waiting And Investing Later?
The short answer to this question is: not always.
Once companies become newly public, they are usually categorized as volatile and high-risk. This is due to the fact that they have no proven history of operating publically.
The chief equity strategist for U.S. Bank, Terry Sandven explains that “Not all IPOs are proven to be long-term winners.
In fact, while many IPOs have flourished, the company path toward financial greatness is littered with failed IPOs.” According to Sanvern, the results from investing in IPOs are typically mixed.
The thing that usually attracts a lot of attention to an IPO is its predicted growth. IPOs are able to trade at a higher multiple when investors are inclined to pay larger valuations for the predicted future growth.
Despite this, the higher valuations could pose a threat if the economy enters a period of slowing. These periods lead to a rise in investor angst and sentiment grows increasingly more risk-averse.
If A Company Is Entering The Public Domain With An IPO, Does That Mean It’s Financially Stable?
Unfortunately for investors, things are not as simple as that. Despite the fact that an IPO has audited financials, the future and predictability of these financials and their stability remain uncertain.
There are many factors that are out of anyone’s control that can affect a company’s fortunes. These factors include things such as government regulations, tariffs, and the pace of global economic growth.
Even the stage in the economic cycle has a large impact on the success of a company. Sometimes these factors work in a company’s favor, sometimes not.
This is rarely the case. This is due to the fact that institutional investors and fund managers are usually the main purchasers of IPOs rather than individual investors.
Because these types of institutional investors have the funds to purchase many shares at one time, they are the dominant purchasers of IPOs.
Investment bankers typically provide companies who are in the process of going public with underwriting services.
They would ideally want to give IPO shares to investors who are more likely to hold their shares over a longer period of time, rather than investors who would purchase shares before selling them on the open market, which would increase the volatility of the share prices.
Once a new company goes public, even if it has a lot of hype and positive media attention, it’s likely that most of the IPO shares will get taken by institutional investors and there may not be any left available for purchase by individual investors.
Therefore, individual investors may be forced to wait until the company trades securities on the secondary market.
Is Investing In An IPO Is A Way To Get Ahead Of The Game?
This is somewhat true, however, many companies are likely to have some private investors before they go public. Therefore, IPO investors may not be the very first to invest, but they are one of the primary public investors of the company.
An important thing to consider is that there is an offering price that is announced before the IPO.
This price is fixed for institutional investors and employees. This price is likely to differ from the price for individual investors once the stock is available to trade on exchanges.
Reasons Why You Should Invest In An IPO:
It’s an opportunity to invest in a business relatively early in its growing process.
Some well-established companies who were privately owned for the long term can sometimes decide to become public, giving investors a chance to have shares in mature, long-established businesses.
Investing in an IPO is a great way to learn about the company and the sector.
Many IPOs are led by the companies’ founders. This is a growing trend, and it has been observed that founder-led businesses tend to perform better. 30% of globally-listed companies from the last 5 years are founder-led.
Reasons Why You Should Not Invest In An IPO
Some IPOs may be overvalued because of the hype surrounding the company. This leads to bubbles and manias, and many companies cannot live up to expectations.
Investing in IPOs can pose a real risk. Short-term investors who look to buy up IPOs and sell them on quickly for profit can cause a lot of volatility in the share price early on.
If you haven’t done enough research and do not fully understand the sector or the market conditions more generally, you should not be tempted to invest in IPOs. Some stocks are more susceptible than others to be negatively affected by regulatory changes and policies.
Make sure you have a broad knowledge of the wider market before you commit to making an investment decision.
The Key Takeaways About IPOs
When looking into a company for a potential investment, it’s important to research thoroughly and approach it with a certain degree of caution. It’s not a bad idea to be a little skeptical when entering into the IPO market.
This is because there is often quite a lot of uncertainty surrounding IPOs and sometimes this is due to a lack of available information. Consequently, you should learn as much as you can about the company and the sector before you make an investment decision.
The average individual investor may find it difficult to acquire shares in a large company that’s ready to go public.
This is because brokers often save their IPO allocations for certain favored clients and institutional investors, and by the time the public has access to these IPOs there may not be many shares left. These leftover shares are the ones that the “big shots” didn’t want or need.
Although many investors who have acquired stock at the IPO price have been rewarded very handsomely, it is still increasingly difficult for the individual investor to sift through the overtly risky investments to find ones that are worthwhile.
This is why it’s essential for investors to stay well-informed and in the loop when it comes to investing in IPOs, and approach each decision with caution and a certain degree of skepticism.
If you are interested in a certain IPO after a lot of careful consideration and research, then you should add the date on which the IPO will be available on the public market. Once it becomes available, stock can be purchased using a brokerage account providing that there are enough stocks available.
As previously mentioned, researching the company that you’re interested in is the most important part of this process. You should also have a good understanding of the competitive landscape of the public market, in addition to the valuations of similar companies.
There may also be risks associated with the specific company of interest, which should be considered before coming to a definitive decision.