| by Oliver |
6 Min Read

Investing in IPO; Is it a wise choice in 2021?

Did you know?

Between 2000 and 2021, there have been 5,538 IPOs. The lowest number was 62 in 2009. The number was at an all-time high in 2020, with 480 IPOs. But 2021 has already surpassed it with 843 IPOs and counting.

An investment in an initial public offering (IPO) has the potential to provide substantial returns. However, before investing, it’s essential to understand how an IPO differs from regular stock investment, as well as the added risks and laws that come with IPO investments.

In this article, you will learn;

– What is an IPO?

– History of IPOs

– What are the Types of IPO?

– What Do You Need to Know Before Investing in an IPO?

– How to Invest in an IPO?

What is Initial Public Offering? 

Initial Public Offering (IPO) is a process by which a company becomes a public company by selling its number of stocks to investors. A privately held corporation puts its stock on a stock exchange, putting it open for the public to purchase. You can become a shareholder by purchasing shares directly from the corporation.

History of IPOs

For decades, the term “initial public offering” has been a buzzword on Wall Street and among investors. By selling shares in the Dutch East India Company to the general public, the Dutch are credited with launching the first modern IPO.

Since then, IPOs have been utilized as a means for corporations to generate funds from the general public by issuing public shares.

IPOs have been recognized for uptrends and downtrends in issuance over the years. Individual industries also go through ups and downs in issuance as a result of innovation and other economic considerations. At the height of the dot-com bubble, tech IPOs exploded as firms with no revenue hurried to list on the stock exchange.

The financial crisis of 2008 resulted in the lowest number of initial public offerings (IPOs) ever. Following the financial crisis of 2008, IPOs came to a halt, and fresh listings became scarce for several years.

Much of the recent IPO hype has been on so-called unicorns—startups with private valuations of more than $1 billion. Whether these companies will go public via an IPO or remain under private ownership is a hot topic among investors and the media.

Types of IPO

Here are the two types of IPOs:

Fixed Price Offering

A fixed price initial public offering refers to the price at which some companies offer their shares for the first time. Investors are informed of the price of the stocks that the firm has decided to make public.

Investors know the share price before the company goes public with a fixed price. When applying for this IPO, the investor must pay the full share price.

For example, consider a manufacturing company that has been in operation for ten years and has decided to expand its manufacturing facilities by acquiring funds. Now, they can either raise capital through debt financing or equity financing. The corporation opts to go forward with an IPO via a fixed-price offering.

They go to their merchant banker, who assesses the company’s assets, future projects, goodwill, and promoter’s equity, on one hand, and liabilities, on the other. Following that, the company files for an IPO and receives approval.

Meanwhile, the firm and the merchant banker decide on a price for the stock after much deliberation. The stock’s face value, or actual value, is $10, whereas the price at which it will be issued to the general public is set at $50. Following that, the public can subscribe to their shares.

As an investor, you can evaluate the company’s business, the promoters’ track record and exposure, and the firm’s prospects before deciding whether or not to register for the IPO.

Book Building Offering

The firm launching an IPO provides investors with a 20% price band on the securities under book building. Interested investors submit bids on the shares before the ultimate price is established. Investors must decide on the number of shares they want to buy as well as the amount, willing to pay per share.

Unlike a fixed-price offer, there is no predetermined price per share. The floor price is the lowest price at which a stock can be purchased. The cap price, on the other hand, is the highest share price. Investor bids are used to determine the ultimate share price.

For example, If the price range for a book-built IPO is $735-$750, a strong response may result in the issue being priced at $750, while a reasonable good response may result in the issue being priced at $735.

Participating in an IPO; The Investment Bank comes first

When investing in an IPO, you need to be aware of various details, including the issue name, issue type, category, and price band, to mention a few. The issue name is the name of the company that is going public. The issue type refers to the type of initial public offering (IPO): fixed-price or book-building. Retail investors, non-institutional investors, and qualified institutional purchasers are the three types of IPO buyers.

The pricing band refers to the price range that has been established for book-building concerns. Since not all brokers make initial public offerings to their clients, IPOs are typically given to qualified or institutional investors first. As IPOs lack a track record of success, they can be riskier compared to stocks of established companies

When a company wishes to go public to offering price, it must hire an investment bank to handle the IPO. Although a firm can go public on its own, it rarely happens. An IPO can be handled by one or more investment banks.

5 things to understand for IPO Investing

What should you keep in mind if you want to invest in IPOs now that the stock price is at its peak? Let’s have a look at a few pointers.

1. Gain a thorough understanding of the company’s operations.

Before investing in an IPO stock, you should learn about the company’s business. You should select organizations that are involved in a business with significant growth potential. A high-growth corporation will be able to maintain steady profitability while also increasing revenue. You should avoid investing in IPOs of firms whose business activities you are unfamiliar with.

2. Look into the company’s history.

Examining the past success of the firm whose IPO stock you’ve shortlisted might help you grasp its business plan better. The company’s promoters should be knowledgeable and capable of propelling the company to new heights. You should stay away from organizations with an inexperienced promoter group and management.

3. Examine key financial indicators 

You can determine the company’s financial health and analyze its development potential by reviewing key financial data. Knowing the debt-to-equity ratio, for example, might help you determine the company’s degree of leverage. A high debt-to-equity ratio frequently suggests that a corporation is riskier. Before buying, you should also look at the company’s earnings per share (EPS), cash flow, return on capital employed, and other critical financial parameters.

4. Compare with the peer group

Another useful tool for evaluating an IPO is to compare it to its peer group. Assume the firm planning an IPO has a high market share and attractive financials in comparison to its peers, but the IPO’s offer price is lower. In that situation, it may present a significant possibility for profit. On the other side, if the company’s IPO pricing appears to be excessively high in comparison to its peer group, you may want to avoid investing.

5. Get a better understanding of why you’re investing.

Investing in an IPO stock for the goal of profiting from the listing may not be a bad idea, but it should not be the main reason for doing so. Listing gains are the profits you make after the stock is listed on the stock exchange. It is the difference between the issue price and the listing price. Massive losing gains are more prominent in high-profile IPOs. You should choose a firm with strong fundamentals that can deliver good long-term returns even if it does not provide listing gains.

How to Invest in an IPO?

Most of the major discount brokers have varying participation criteria, but you must have an account with one of them to invest in an IPO through that broker.

Do your homework.

Since there is no prior data or market performance history behind the firm at hand, IPO research might be intimidating. However, the Securities and Exchange Commission (SEC) requires that all companies file an S-1 form to register their offers. This form primarily contains corporate background information, financial information, and a prospectus for the offering.

Request Shares.

If you meet the eligibility requirements for an IPO, the next step is to request a certain number of shares in the offering. It’s possible that you won’t get all of the IPO shares you offered to acquire. Instead, you may be given a “pro-rata” share allocation. Consider your request to be the maximum amount of shares you’d like to purchase if they’re available.

Make a Purchase

Your broker will advise you that the offering is moving forward on the evening the IPO “prices.” A deadline will be set for you to place your order. You cannot be certain if you were able to get any shares.

If you decide to invest in an IPO, you should read the S-1 prospectus, which is a document filed with the Securities and Exchange Commission that contains specific information about the firm, including financial performance, growth prospects, and insider ownership and voting rights.

Is it a Good idea to Buy IPO Shares?

You shouldn’t invest in an IPO just because it’s getting a lot of favorable press. Extreme valuations show that the investment’s risk and reward are not favorable sometimes.

Investors should be aware that a firm issuing an IPO has no prior experience operating publicly. Furthermore, the market’s competitive landscape may have an impact on an IPO’s performance. These and other variables could stymie an IPO’s success and make an investor’s decision more difficult.

Key Takeaways: 

– The process of issuing shares of a private firm to the public in a fresh stock issuance is known as an initial public offering (IPO).

– To hold an IPO, private companies must meet the standards of exchanges and the Securities and Exchange Commission (SEC).

– IPOs allow businesses to raise money by selling shares on the New York stock exchange.

– Always read the new company’s prospectus before investing in an IPO stock.

– Investment banks are hired by companies to market, evaluate demand, determine the IPO price and date, and other tasks.

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