Going public through an initial public offering (IPO) of stock can be an effective means of raising cash for corporate ventures. And with proper research, IPOs can bring investors a great return on their money.
But before undertaking the investment, you must understand the upside and downside of IPOs.
With news of investors making millions on their investments in an IPO, it makes sense that other investors would be interested in following their lead and getting in on new IPOs.
Because today’s IPO market is filled with companies that are launching new ideas and innovative technology to the public, there are many pros and cons to IPOs that you must understand.
IPOs come in many types and there are many factors to be carefully considered before you consider investing.
In this post, the information you’ll discover will serve as a starting point for your own investigation for investment in IPOs.
Post-IPO profitability in the U.S. 2008-2020
An initial public offering (IPO) is the first time that stock of a private company goes on sale to the public.
IPOs are most often issued by smaller companies that want additional capital. But IPOs sometimes are performed by larger companies that want to become publicly traded on stock exchanges.
According to research, the share of companies in the U.S. which were profitable after their IPO has been falling over the past decade. In 2020, only 22 percent of companies were profitable after their IPO.
China has recently emerged as a leader in the IPO market. However, the U.S. remains close behind in regards to IPO volume. To date, the largest IPO in the U.S. was Alibaba Group Holding in 2014, in which 21.77 billion U.S. dollars was raised.
The IPO offering of Saudi Aramco, a multinational petroleum and natural gas company in Saudi Arabia, was the largest public offering globally as of July 2021. The IPO of Saudi Aramco raised approximately 25.6 billion U.S. Dollars.
Why do companies opt for IPOs?
An initial public offering (IPO)is the one-time event when a company first offers stock for sale to the public. This is commonly called “going public.”
IPOs happen when a private company decides to open up shares on the stock market, taking the first step to become a publicly traded enterprise. Shares are traded in the open market after the initial sales, and any public investor can take part on the trade.
Smaller sized companies may seek an IPO for access to capital and cheaper credit for further expansion. Opening up to the stock market can also encourage mergers and acquisitions, since stocks are often a consideration in future deals.
2020 was quite a year for IPOs. In 2020, there were 407 initial public offerings (IPOs) in the United States. This was more than twice as many as in the previous year.
What does it mean to go public?
In a private company, the management team has a lot of control over the operation of the business. But a private company has limitations in raising funds from investors. To access new capital from the public, firms offer stock shares at a particular price.
As a result of this process, firms often have more capital to work with. An IPO can, and often does, raise billions of dollars for a firm.
However, publicly traded companies also face increased regulation and disclosure requirements.
Because of this, some firms delay going public for a longer time, in spite of their increasing value.
Some firms, such as SpaceX, are still investing heavily in research and development projects, which shareholders tend to not value.
Use an IPO Profit Calculator
Calculating your profit for an investor is different than the stock shares granted to an employee.
If you are an employee, you must look to see if you were granted stock options or RSUs.
The first step is to use an IPO profit calculator. There are many calculations to consider. The first one to consider is the employee lockup period expires matters a lot. Additionally, you must take into account company withholdings, state taxes, federal taxes.
If you are an employee, not an investor, it will be helpful to use an IPO calculator to figure out what you will take home.
IPO Risk Factors In Applying for an IPO
When it comes to applying for an IPO, there are a variety of risks to consider. These risk factors can dampen the future growth of your investment.
The various risks that are involved in applying for an IPO are as under:
No guarantee of getting the shares
The greatest risk factor in applying for an IPO is that you won’t get the number of shares you want. There are many reasons why, but the gist of all of them is that there are too few shares being offered, so the price of the shares vary greatly. That means that the shares you want at a certain price might not be available.
Not getting your price
Similar to above, the price fluctuations may mean that the price for the IPO will go up immediately. The initial price is the price at which those shares start to exchange on the open market and will likely change as soon as the shares start trading.
External influences can affect the price
The stock market is a fickle beast. Depending on the mood of investors, an IPO can be valued immediately or it can tank upon release. There are many factors that are combined and influence the price of an IPO after it’s debut.
Money gets locked for some time
Another significant parameter is the fact that funds get locked up for a particular period of time in an IPO and this cannot be considered beneficial, considering the fact that there are various other investment needs and requirements that need to be taken care of during this time.
These are just a few of the reasons. You can see that IPOs do have their own share of risks involved. Be sure to considered these risks when you are evaluating your IPO investment.
How Long After IPO Should You Buy
In normal conditions of the stock market, there is some match between supply and demand. If there’s good news about a company, demand goes up and a new price is set.
In an IPO, the supply and demand economics are a bit different. The supply of shares is limited. If the price goes up, there may not be that many more shares available.
Additionally, there is not a way to short-sell an IPO stock on day 1. The other reason for the limited supply is that a lot of shareholders have agreed to some type of lock-up, promising not to sell any shares for a certain amount of time.
The media and news hype about the IPO increases demand, even though there is limited supply. This is why you see a “first day pop” of the IPO share price.
It’s helpful to see the first day returns on the IPO shares of some of the big name IPOs of the past couple of years.
Example One: In 2013, Twitter was up 73% at the end of day 1, after peaking during the day at more than double the IPO price.
Example Two: In 2012, Facebook’s share price went up only 1% at the end of day 1, after peaking at 18% above the IPO price during the day.
Similar results have been seen for other IPOs.
As you can see, it’s very difficult to guess the timing of the buying or selling of shares on a very volatile first day of trading. It’s easy when you have hindsight, but impossible when you are in the middle of it.
Further, overall market sentiment can be schizophrenic, moving from frenzy to depressed in one day.
Lastly, day one gains are possible, but certainly not guaranteed.
What about the longer term share price performance of these companies?
The best way to consider this is to review the quarterly and annual cycle of earnings releases and updates. Twitter’s share price stayed above the $26 IPO price for a few years, then dropped below it, then recovered above the IPO price.
Facebook’s share price dropped well below the $38 IPO price. But from there, it recovered to a peak of over $200.
As you can see, it can go either way medium or long term, just like any other share price in the stock markets.
Final Words on IPOs
There are pros and cons to investing in IPOs. With so many IPOs launched each year, if you do your own due diligence about the companies and you might be able to uncover the next big IPO winner.
Investing in IPO can only be profitable if you have done your research and stick with the stock over the long term.
This is why IPOs are perfect for those people who are willing to take the time to research and analyze the situation. Of course, there is risk in any investment and IPOs are no different.
Yet for the right company, IPOs offer you the opportunity of buying cheap and participating in the company’s prosperity as it expands and grows in the coming years.
Before you invest, be sure to do your own analysis. And be sure to consult a professional financial advisor for additional advice to answer any further questions you may have.