IPOs can offer big returns for those who get in early.
In this post, you’ll discover the most common questions about investing in an IPO. It points out several key points that all investors must know before they invest in an IPO.
In addition, this post will enable you to understand key fundamental ideas of an IPO, as well as give you several other ways for getting in an in IPO.
If you’ve been considering putting your money into an IPO, then this information is for you.
Basics Of An IPO
Before we get started, let’s get into the details about an IPO.
As a private company grows, it sometimes reaches the point where they need to raise additional capital. If the company wants to raise additional capital through public shares, it will go public and issues stock to the public. This process is called an IPO, initial public offering.
The IPO is underwritten by an investment bank, broker-dealer or a group of investment banks and broker-dealers. They purchase the shares from the company and then sell (and distribute) the shares at the IPO to investors. Until the IPO happens, the company remains private.
Investment bankers use their network to find buyers for largest chunks of shares. Depending on the company, this may be easy to do by selling to institutional investors and larger fund managers.
Because the company is trying to raise capital, having institutional investors buy large segments of the shares is an easy way to get lots of money. And it’s easier to sell a million shares in large lots.
The initial public offering sells only a limited number of shares so the big institutions don’t get all of the shares they have requested. With some IPOs, no one party gets 100 percent of the shares they have requested.
Who Gets To Buy an IPO
For many individual investors, it will be hard to get in on the next big IPO. Instead, it’s the big institutional investors who get access to the IPO shares.
Because of the relationships with institutional bankers, the investment bankers underwrting the IPO deal offer the shares to them first. It’s these relationships that are the main reason investment bankers are chosen.
This is why institutional investors have an advantage over others. The shares go to the customers of the investment bankers.
For an individual investor, it may be hard to get in on the IPO. Instead, management, employees, friends and families of the company going public may be offered the chance to buy shares at the IPO price in addition to investment banks, hedge funds and institutions.
However, for some IPOs, most investors are locked out until they hit the public exchange.
Finding an IPO and getting in
Once the stock is trading on the exchange, single private investors and big-time professionals have plenty of opportunities to buy shares. In fact, waiting for a stock’s actual debut can be a smaller investor’s best strategy when it comes to new public companies.
As soon as the underwriting bank sets the price and it starts trading on the exchange, individuals can start buying IPO stock.
Are IPOs Profitable
Simply put, some are profitable, some are no.
The #1 mistake of beginning IPO investors is that they fall in love with a stock that has already risen a lot, overpay for it, then end up regretting it.
However, sometimes you’re better off buying IPO stocks after a bump rather than waiting. It may sound crazy, but that’s the special nature of an IPO.
An IPO is when a private company offers company shares to the public for the first time. And after you have studied the IPO market, you discover that IPOs are some of the most explosive stocks on the planet.
It’s not uncommon for a stock to double just months after going public. And after decades of IPOs, some patterns come up again and again. For example, the best performing IPOs tend to be for tiny, fast-growing companies that are under-the-radar of most analysts.
And another important factor is first-day performance. IPOs that bust out in the first few days are far more likely to continue marching higher for months, and sometimes years.
For example, HubSpot is a sofware company that went public in 2014 and it spiked 32% on its first day of trading. From there, it nearly doubled in value over the next 14 months. Five years later, it traded 731% above its IPO price.
Here’s another example. Inspire Medical Systems (INSP) is a medical devices company that public in 2018. It jumped 53% on its first day of trading. Over the next 15 months, INSP tripled in value.
Sometimes IPOs take off and move up in price only a few weeks or months after their initial debut.
Some Ways to get in on an IPO
If you want to get in an on IPO, you may have to wait. You see, the concept of an IPO has suffered from a poor choice of naming. IPOs are not completely public.
The investment bankers who are underwriting the IPO use a process that is a challenge for individual investors to get early shares of an IPO. Large blocks of IPO shares are first sold at the initial offering price to the large clients of investment banks.
These clients are mutual funds, hedge funds, or pension funds, and they are then free to sell the shares on the open market on an exchange. This usually happens the day after the IPOs are sold to the initial investors.
Investors then have to wait until the IPO starts to trade on a stock exchange before they get access to shares.
However, there are some other alternative methods for you to find a way to get into the IPO process.
Here are some ideas:
Work with your online brokerage. Most of the major online brokerage firms have cut deals with select investment bankers to get shares of IPOs.
For example, the online brokerage Fidelity has done a deal with Deutsche Bank and Kohlberg Kravis Roberts (KKR) to get shares of certain IPOs at the offering price. Check with your online brokerage to see if it offers shares for any upcoming IPOs.
Build a relationship with an investment banking firm. For popular companies with an IPO that will be in high demand, investment banks underwriting the deal will give shares to the client’s own customers. If you believe buying IPOs will be a popular choice for you, you can consider creating a brokerage firm account with one of the investment banks that’s doing the types of IPOs you’re interested in. Keep in mind, though, that the brokerage units of investment banking firms tend to charge much higher commissions and fees than discount brokerage firms, so you must factor that additional fee into your consideration.
Buy a mutual fund. Since mutual funds are often customers of the investment bankers handling the IPO, you can grab shares of the IPO by investing in a mutual fund. Research tools like Morningstar allow you to find out which mutual funds typically get shares of IPOs. If you own a mutual fund that gets shares of hot IPOs, you’re in.
Wait and See. Sometimes the best action is taking no action. IPOs are risky investments that can decline in value in the first hours, days, and weeks of going public.
Rather than rushing to buy IPO shares at the offer price, it may be a better investment to wait and see how the market reacts to the IPO. If you had waited a few months after Facebook’s IPO, you would have had a deal. Shares of the company crashed about 40 percent from its offering price just months after its IPO, meaning investors who waited got the shares for 40 percent less than the initial investors!
Final Words and Wrap Up
Investing in an initial public offering, or IPO, is a great way to earn a lot of money if you put it in the right company. You can also get in on the ground floor that helps a company grow into something that could be very profitable. There are risks involved with any investment, but for those who are willing to take on those risks and reap the rewards, an IPO is worth looking into as one possible avenue for doing so
It’s important to take time and weigh all of your options before investing in an IPO, because it could be better for your future financial stability to do your due diligence to carefully consider your investment before committing yourself to putting money into an IPO as a part of your investment strategy.