It is important to have some idea of how to choose the best initial public offering available at any given time. Having that knowledge can help you make a profit in the short-term or long run. It also saves you from investing in any company whose share prices might plummet a few years from now.
By description, an initial public offering (IPO) talks about the sale of a firm’s private shares to the public. Therefore, the company becomes a public entity after the offering. The investors who have shares in the company can benefit from the price surge of these shares.
An IPO is known to help companies raise funds that are directed towards promoting the growth of the company. In most cases, the offering comes with premium shares for the company’s investors. It also offers interested public investors a chance to own some of the company shares.
IPOs are overseen by underwriters who mainly ensure that the company meets all set regulatory requirements. The funds acquired from IPOs are mostly used for research, marketing, developments, and in any other area that needs improvement urgently.
Initial public offerings come with many potentially profitable opportunities for private investors. These investors are mostly the early investors or angel investors who have sown into the company. When the company eventually goes public, it allows these investors to sell their shares for cash. The sale is fully optional which means that the individuals can still hold onto their shares.
There is a requirement for the companies seeking to launch an IPO to meet the SEC’s guidelines on public companies. The firm must also have a certain valuation which in most cases is $1 billion.
Nevertheless, companies do not need to reach this valuation before going public. In these scenarios where valuation is lower, companies need to possess a huge potential to grow and should also have strong fundamentals.
How To Choose The Best IPO
There are certain factors that you need to look out for as you plan to buy your first shares in any company that is going public. These factors are important when you consider various companies like VA Linux whose yields were highly impressive at first. Nevertheless, the gains did not last in the long term which resulted in losses for the investors.
Hence, you can minimize the probability of losing money while investing in an initial public offering by implementing different measures and taking precaution:
It is your money that is at stake. Thus, it is advisable to do an extensive background check on the potential company that you want to invest in. Please note that some information might be hard to find since the company is still private. But, you can check out what analysts and other interested parties have discovered.
Analysts review the companies and try to find their loopholes. But, many private companies offer all the necessary information about their financials and everything else to the public. The only challenge is that the information provided by the company that wants to launch an IPO may be biased to some point.
Hence, your investigation may be necessary to shed some light on what the company is really up to. It is advisable to research on the company’s profile, latest news, finances, the health of its industry, and a lot more. If you discover that its goals are unachievable, it could be a red flag for you not to invest in its IPO.
Review The Prospectus
The company’s prospectus that outlines its risks and its intentions with the money it gets from the IPO is important. Hence, ask from the brokerage firm for it even before investing your money to buy shares in the offering. It might be tedious to review the prospectus but it could save you from losing your investment.
For example, if a company wants to use the money it gets to repay loans, that is a reason for concern. That means that it is already struggling with its loan repayments and the money acquired from the IPO will not be used to promote its growth. Also, if the company wants to use the IPO money to buy equity from its private investors, you should proceed cautiously.
A deal is good whenever the company that launches the offering wants to invest the money acquired into research, marketing, and expansion of the business. In the end, if the deal is too good to be true, it may be blown out of proportion.
The expected returns may be almost unattainable or the roadmap may be unrealistic to meet these targets within the specified period. While a prospectus should not play a major role in deciding whether to invest or not, analyzing it keenly is important.
Go For The Company With Strong Brokers
Brokerage firms and underwriters present potential companies that you can invest in. Nonetheless, it is always important to go for a company that has the support of a strong brokerage firm. If the firm is highly reputable, it attracts the support of reliable companies with huge potential to offer returns on investment.
For example, Goldman Sachs is highly selective of companies in which they associate and invest. That might not be the case for a small brokerage firm.
No need to say that you stand to gain a lot from using a boutique broker since they are willing to allow investors to buy pre-IPO shares. However, there are instances where the large firms may prohibit first investments to be in IPOs. If an individual can invest in such a company, it is only the wealthy investors who have a strong reputation.
You may be eager to dive into the initial public offerings market instantly. But, it is advisable to catch your breathe and show some level of caution. The uncertainties that surround the outcome of these investments make it important to be cautious. More caution is needed whenever a broker recommends an IPO to you.
In most cases where a broker recommends an IPO to you, it may be one that the institutional investors are not interested in. Thus, the offer shifts to retail investors which shows that the IPO has little or no potential in providing a lot of profit. Hence, your broker’s recommendation may not be inspired by their desire for you to earn, but instead, they just want to sell a pitch.
You should also keep in mind that brokers may show a lot of favoritism by offering the IPO shares to their ‘special’ clients. Therefore, it may be challenging for a normal investor to get a chance to buy the shares. That means that if you are suddenly given an investment chance on a gold platter, think twice before taking it.
Wait For The Lock-Up Period To End
There is always a lockup period for stocks to be held by private investors. It is legally a must for these parties not to sell their shares until the lockup period elapses. That means that even if the price of the stock explodes, they are legally needed to hold it.
On the other hand, you might be blinded by the surge in the stock’s price and decide to buy in. But then, it is advisable to wait until after the lockup period had ended. After this period, private investors can sell their stocks which might affect the price of the stock.
On the contrary, if the investors decide to hold onto their stock after the lock-up period ends; it means that they are confident about the company’s future. That is a bullish sign which you may use to invest in the company.
Is It The Best IPO?
There are various questions that you need to ask yourself before you make any investment in an initial public offering. These are the questions that enable you to determine the potential of the IPO in question. Therefore, consider the following:
Is The Company Launching The IPO Stable?
This is the part where you will need to fall back on the company’s prospectus. It provides you with an idea of whether it is stable or not based on the company’s earnings and revenue in the past several years.
Thus, it is important to consider whether the investment that you want to make is going to end up in a growing company or one that is on its knees.
How Much Are The Stocks Worth?
The price of any company’s stock when it hits the market is an essential factor to consider. Normally, the price range at which the stocks will get sold may be disclosed by the company when it publishes its prospectus. However, the price range is mostly revised when the IPO is close. Apart from the price, it is advisable to consider the valuation of the company launching the offering.
Do Management Members Have Shares?
The company’s prospectus reveals the payment system set up for the management. Professional investors always prefer to invest in IPOs from companies whose management team has a large holding of the stock. It shows that management believes in the company’s future.
What Will The Funds Be Used For?
It is important to ask yourself how the company intends to use the money that it collects from the IPO. Good use of the collected money ranges in the expansion of the business as opposed to paying private investors who are eager to sell their shares.
There are ways that you can use to determine the best IPO for you to invest in. Following the tips outlined in this guide; you can have the ability to choose the best offering that will provide high returns on investment in the long run.