Investing in the stock market is one of the most lucrative ways to make money and grow your net worth. At the same time, an investor must ensure that his portfolio contains a diverse range of stocks to spread out the risk. But for most newcomers, investing in the stock market is challenging. Ensure to research and learn about all the different business approaches before considering investing in the stock market, where the value keeps fluctuating.
Investing in an IPO can lead to significant returns when it’s done right. It is necessary to learn the differences between the trading process of these securities and regular stocks and to understand the added risks and limitations connected with IPO investments before investing.
Understanding every investment approach and strategy is paramount for a newcomer. The following article can guide you if you are contemplating investing in an IPO.
What Is an IPO?
An Initial Public Offering, or IPO, is the process through which a privately owned company turns public by issuing stocks to the public for the first time. The company that publishes its stocks to the public is called an “issuer.” It does so with the direction of several investment banks. The company stocks are traded in an open market after the IPO.
Commonly, companies issue an IPO to raise funds for paying off debts, encourage fund growth initiatives, or improve their public profile. Through increasing its capital, a company can effectively grow its business by selling its stocks in an open market. Whether it is a brand-new company or has been running for years, it may agree to go public through an IPO. Company insiders can use an IPO to broaden their holdings or create liquidity by selling all or some of their private stocks during the public offering.
Getting Involved with an IPO
Choosing a company considering going public is the initial step to getting on with an IPO. Searching S-1 forms submitted to the Securities and Exchange Commission (SEC) can help you do this. An investor needs to register with a brokerage company to get involved with an IPO. Companies that issue IPOs inform brokerage companies, who subsequently advise the investors.
Before getting involved in an IPO, investors often must satisfy specific requirements, as per most brokerage firms. Some believe that only a few investors are granted access to IPOs if they hold a particular sum of money in their brokerage accounts or have carried out a certain number of transactions. If you are eligible, the company will require you to register for IPO notification services to ensure you receive notifications about new offerings that meet your investing requirements. Here are some tips to keep in mind when considering investing in an IPO:
Research Objectivity Deeply
It is tough to discover information on companies that are preparing to go public. Generally, private companies do not have groups of analysts covering them, searching for any possible flaws in their corporate defense, unlike most publicly traded companies. Though most businesses aim to disclose every detail completely in their prospectus, it is still developed by the company and not by an objective third party.
Be mindful of all the details concerning the business, its finance, rivals, previous press releases, and the industry’s status. Although getting accurate information can be challenging, conducting research on the companies is vital when making a prudent investment. On the contrary, your research can also indicate that a company’s potential benefits of a business are being overestimated. This may suggest that passing on the investment opportunity would be a wise choice.
Select a Firm with Skilled Brokers
It is advisable to pick a company that has a credible underwriter. The case is not that big investment banks never make subpar investments public, but quality brokerages are often connected with quality. Smaller brokerages should be picked with caution because they might be keen on underwriting any business. For example, given its reputation, Goldman Sachs (GS) can be selective about the companies it underwrites, unlike a much smaller, unfamiliar underwriter.
Given their limited client base, boutique brokers have the single advantage of enabling private investors to purchase pre-IPO shares easily. However, this advantage could also serve as an indication of danger. Be mindful of the fact that big brokerage firms will not permit the first investment you make to be an IPO. The only individual investors involved in IPOs are often well-established, long-term, and frequently high-net-worth clients.
Wait Until the Lock-Up Period Is Over
The lock-up period is a legal agreement between a company’s underwriters and business insiders that restricts investors from selling any stock shares for a predetermined period. It can be anytime from 3 to 24 months.
Waiting until insiders sell their stock shares is a smart move, given that continuing to hold the stocks even after the lock-up period ends could indicate that the company has a positive and sustainable future. It is unlikely that the insiders would be willing to accept the stock’s spot price over the lock-up period. Before making a choice, let the market take its course. Regardless of whether the lock-up period has ended, a good company will remain sound, and the investment will be worthwhile.
Read The Prospectus All the Time
Although placing your entire trust in a prospectus is not wise, you must still read it. It might be an uninteresting read. However, the prospectus, which you can obtain through the broker managing the company’s IPO, explains the opportunities and subject risk alongside the expected uses of the funds generated by the offering.
It is advisable to refrain from participating in the IPO, for instance, if the funds are meant to pay off debts or purchase stock from founders or private investors. This is not a good sign and indicates that the business cannot fulfill its obligations without selling stocks. Undoubtedly, it is better when the funds are allocated for advertising, research, or growing into new areas.
Furthermore, an unduly optimistic expectation for future profitability is among the most important things to be mindful of when reading a prospectus. It is of the utmost importance to read estimated accounting data attentively, considering that individuals often strive for market success, overpromise and fail to deliver.
Open A Demat Account
It is advisable to open a Demat account to invest in an IPO. Any of your physical shares can be quickly transformed into electronic form through a demat account. Dealing with physical shares used to be such a hassle, but the introduction of Demat has solved such issues. You cannot sell or purchase stock market shares without a Demat account. Ensure to open a Demat account with any authorized Depository Participants. However, you can open a Demat account irrespective of whether or not you have any shares in your account.
Take Extra Caution
A healthy amount of skepticism is a good thing in the IPO market. As stated previously, there is a good amount of uncertainty around IPOs, mainly given the unavailability of information. As a result, it is advisable to act cautiously when dealing with them.
This is possible if your broker suggests an IPO. When it occurs, it generally indicates that most institutions and money managers have politely refused the underwriter’s proposal of selling them the stock. Individual investors are likely obtaining the bottom feed, in this case, the leftovers that the “big money” refused to take. Undoubtedly, there is an explanation for the availability of shares if your broker continuously pushes a particular offering.
Highly profitable companies will often go public. However, it can be tough to identify the ones with the best prospects. Nevertheless, that does not imply that all IPOs should be ignored. Only some investors who purchased shares at the IPO price have gotten significant payments from the relevant companies. However, when dealing with the IPO market, skeptic investors who are well informed of the situation will probably witness their investments do well compared to those who are naïve and ignorant.