With a large number of IPOs lined up for the coming months, this year is believed to be a record year for investing in IPOs. IPO investing provides smart investors another avenue to enter the market.
However, like the stock market, IPOs come with their fair share of risk, and due diligence is required before investing in them.
For even though the financial media like to talk about the big winners from IPOs, the truth is that there are many failed IPOs, and even more that perform only average. So while many IPOs come with great hype, investors must exercise caution and do their homework before buying.
To adequately prepare for investing in IPOs, here are some key points to consider.
Understand the Business, Industry, and Opportunity Before Investing In An IPO
Nobody makes money by tossing a dart against a wall of charts.
Neither should you. The key to making money with a winning IPO has more to do with your mind, than with your money. You see, IPOs represent the first-time a company is selling shares to the public. And these public shares represent millions, hundreds of millions, and even billions, depending on the company. For you as an investor, to boost your success will depends on one simple idea – remember you are buying a business.
That’s why you must take time to understand the business behind the IPO before you can something here for your guess.
Once you’ve business, moving to the industry and the opportunity in the market could be the next step. Knowing the business and industry will give you a significant advantage over the others who have not done the same level of due diligence as you.
Conversely, if you do not take time to truly analyze and understand the opportunity behind the business and the industry, then it is probably best to sit out the IPO, until one come around where the opportunity is clearly visible to you.
Key Strengths and Strategy of the Company
Next move your research to discover the advantages of the company and the greatest strength of the company in their industry, with their product or service.
Consider the positioning of the company, as well as it’s ability to continue with it’s current plans. IPOs bring billions of dollars of new capital into a company. And this gives it significant resources to continue on it’s current plan. So it’s best to understand their strengths, because they will have more money to continue on their trajectory in the industry.
By researching more about the company, its positioning and strategies, a great deal of insight can be determined about the future path and something of the business.
If you feel that the company has somehow achieved a significant advantage in the market. Then you may want to invest in the IPOs, so you can take advantage of the company, as it arises and moves ahead in the industry.
Calculate The Valuation and the Financial Health of the Company
Remember, the financial performance of a firm may only make sense in a larger context. In your analysis, review several years of data and projections so you can determine if profits and sales are trending up, falling off, or staying the same. If the numbers are increasing, it may be a good investment. Investors should try to understand the company’s financial health before buying an IPO. One should also check the valuations, because the offer price may be undervalued, fairly valued or overvalued, depending on th ..
Of course, all of this qualitative research should lead to quantitative as well.
It’s now your turn to check the numbers and data for specific numbers on the valuation of the company. The valuation number is your benchmark for comparing the initial issue price of the stock, and comparing it with you own numbers.
While are calculating, you should be seeking to understand the financial health of the company. If profit and revenues are trending up, while costs are being maintained, the company may be a good example for your next investment. Combing your own financial due diligence with the issue price of the IPO, you’ll be able to determine if the IPO is a good deal, or if you should wait for the next IPO to invest in.
Check the Comparables and Competition of the Company
Investors should study the competition in the industry.
One thing is for something. When the company moves into the market, the existing companies who are in the industry will not sit still. They will react and will to wahtever new products and service will be introduce by this company. You can use your competitive research to find out how the company will operate in the industry.
This step is vitally important if the new company will be going public in a highly competitive market. You can use the research from the previous steps to make your determination of the companies ability to succeed after they have gone IPO.
You can also use your valuation and financial data from the previous step by comparing it against other valuations of the competitors.
Review The Management Team
Review the leaders, owners, and management team that is running the company. The company’s performance comes from the day-to-day decision-making made by management, and the rise of the share price will depend on the decisions made by the management team. Evaluate their experience in the industry, as well as their past experience. Then consider that research in the context of this IPO’s products and services.
In many cases, attracting an experienced management team is one of themost important things that a startup can do. It’s not a guarantee of success, of course, but it is a solid indicator that gives you a nice green checkbox in your favor.
In addition to having a solid track, a strong management team knows how to build a strong workplace culture. A strong work culture is another vital indicator of a long-term success of a company.
Review The Share Price Of the IPO
The top mistake made by IPO investors is that they get swept up in the wave of media hype, then fall in love with a stock. This results in the IPO experiencing an initial ‘pop,’ causing the stock price to skyrocket. Depending on the company, this price may be too high of a valuation for what the company intrinsic value is.
Sometimes an investor is better served by waiting to buy, after the first bump has dwindled.
Because an IPO is the first time shares of a private company are made available on the public market, the excitement creates a frenzy of buying that sends the price upward. You’ll sometimes see the stock price double in just a few months after going public.
Many IPOs that pop on their first few days may or may not continue on their upward trajectory.
Check Major Risk Factors
Consider the major risk factors before you invest. These factors will vary with each company and with each company. You will have a head start to this activity by following the guides in this report. For each risk factor, consider what the numbers and your research are telling you, then compare that to the projections and plans of the company.
Highly competitive markets can be a challenge for new companies. That’s why comparables are so important in your research. You can determine if the new company projections seem realistic when they are compared to other firms already operating in the same market.
On the other hand, you have the opposite issue with new markets. Because there are no comparables in new markets, you will need to dig into the companies plans and evaluate their assumptions about their calculations and projections.
This is only the start, but it gives you an idea for beginning your own risk factor analysis.
What Are The Future Plans For The New Investments?
In your research, find out how the new capital will be used. IPOs can raise billions of dollars for the company, so it’s important for shareholder to be aware of how that capital will be spent.
If the new capital will be used for growth and expansion, then that may make the company a long-term success. On the other hand, if the funds will be used to pay debt, then that may be a red flag, as the company might be carry too much debt today compared to it’s revenue. Consider the future plans for capital carefully when you are considering investing in an IPO.
Anticipate Long-Term Growth Horizon
If you are going to hold the stock long-term, then it’s best to have a clear outlook on the future growth potential of the company. After you invest in the IPO, you’ll want to know that you’ll have an adequate long term return.
It’s best to be clear from the outset whether you are investing for a short-term quick profit on the IPO listing day or if you’re holding them long-term because the company has future growth potential. A short-term strategy depends on very different factors than a long-term outlook.
It’s also important to consider the offer price in these outlooks. Is the price set by underwriters reasonable or is the IPO price inflated due to media hype?
Your IPO valuation will vary on the growth projections of the company. Since the capital raised through the IPO will often fund the future growth, the sale of an IPO depends on the company’s projections and future growth plans.
Always Read The Public Financial Forms
In order to find the information mentioned in this post, as well as your own questions, you will need to do your own research. New IPOs usually are with young companies that have a limited opertaing history, so it can be tough to assess and value them. A limited operation history means there is little data available for review.
This lack of data is especially true when the industry of the company is new and developing. To gain insight into the inter-workings of the company and how the stock is valued, investors can look at the registration document required by the Securities and Exchange Commission for all new securities.
This form is officially known as Form S-1, or the Registration Statement Under the Securities Exchange Act of 1933, the offering document must contain specific information for investors, including financial data, possible factors of risk, and market information related to the industry. This document can be found on the SEC’s website, and it is normally loaded with caveats and disclaimers.
As mentioned early, use this form to find out how the company plans to use the money raised in the IPO. Will it be to fund capital expenditures? Bring in more employees? Fund new acquisitions? Pay back debt? Fuel new product development and innovations?
When you go through this document, you can find information about the new company to make a call about the valuation — is it worth buying at the price people are selling?
Final and Wrap Up
As you can see, there are pros and cons to investing in IPOs.
Before you invest, perform your own analysis. It will be well worth your time because it will give you peace of mind about the future of the company before you commit with your own funds. And be sure to talk with a financial professional should you have additional questions about a particular IPO investment.
If an IPO hits it big, even a modest investment can return above-average gains. History is filled with stories of the early IPO investors in Google, Amazon, and Facebook.
That said, many IPOs are launched every year, so by carefully considering your own analysis and doing your own due diligence, you may discover another major IPO winner.