How to Choose the Best IPO to Invest In?

UTC by Osaemezu Ogwu · 8 min read
How to Choose the Best IPO to Invest In?
Photo: Depositphotos

Knowing how to choose the best IPO to invest in can help you make a profit in the short and long run. It’ll also save you from investing in a company whose shares will devalue a few years from now. Here’s a guide to help you begin.

Initial Public Offering (IPO) talks about the sale of a company’s private shares to the public. Hence, the company becomes a public entity. Investors who own shares in the company can, therefore, benefit from the price surge of these shares.

It follows that an IPO helps companies to raise funds. These funds can be channeled into promoting the company’s growth. Specifically, it’s usually used for research, marketing, and any other area that is in dire need of improvement. The IPO is also overseen by an underwriter whose major role is to ensure the company meets all regulatory requirements.

Another notable benefit of an IPO lies in the profit potential for private investors. These are early investors or angel investors who have sown into the company. And when the company goes public, it offers these investors a chance to sell their shares for cash. The sale is entirely optional, which means these individuals can still hold back on their shares.

There’s a requirement for companies looking to launch an IPO. First off, they have to meet the SEC‘s guidelines pertaining to public companies. The firm also has to have a certain valuation, which is often $1 billion. However, it is not crafted on a stone that they must have this valuation before going public. In such cases, the company must have a high potential to grow coupled with strong fundamentals.

Top 5 Tips for Choosing the Best IPO

The tips for investing in IPOs are important even before you buy your first shares in any company going public. These tips are essential when you take a look back at companies like VA Linux whose yields at first were more than impressive. However, these gains didn’t last in the long run and it led to losses on the part of investors.

Therefore, you can reduce the chances of losing money while investing in an IPO by implementing the following measures:

Carry Out A Research

It’s your money and as such, your duty to do a background check on the potential company you’ll be investing in. Keep in mind that you may not easily lay hands on information pertaining to the company given that it is a private one, to begin with. There are also a few analysts reviewing these companies and trying to discover their loopholes.

Nonetheless, there are several private companies that provide full information pertaining to their finances, etc. to the public. The only problem is, this information may be written by the company in question and thus, biased to a point. Therefore, your own investigation may even throw more light on what the company is actually up to.

You’ll be searching online to discover the company’s finances, the latest news, the health of its industry, and so much more. And don’t get surprised when you discover that its goals are totally unachievable, which could be a red flag. Hence, you’re better off staying away from such investments.

Go Through the Prospectus

The company’s prospectus outlining its risks, what it intends to do with the money it sources from the public is important. Therefore, ask the brokerage firm for it even before dishing out your hard-earned money to buy shares. It may be boring and less exciting to read, but it can save you from throwing your money down the drain.

For instance, if a company aims to use the funds in repaying its loans, then it calls for concern. This is because it is already struggling with its loan repayments, and the IPO funds will not be promoting its growth. The same goes if the company wants to use the funds to buy equity from its private investors. A better deal is if the company wants to put the money into research, marketing, etc.

Over and above that, if the deal is too good to be true, then it may have been blown out of proportion. The expected returns may be unattainable or even the roadmap unrealistic to meet within the specified timeframe. While a prospectus should not be the major deciding factor whether you invest or not, analyzing it is also important.

Settle for a Firm Backed by Strong Brokers

Underwriters or brokerage firms will present potential companies you can invest in. However, it’s better to settle for a company with a strong brokerage firm. If the firm is notable, it’ll put in the extra effort to underwrite companies with high potential. There’s Goldman Sachs, for instance, that’ll be very selective of companies in backs. The same may not be the case for a small brokerage firm.

Needless to say, you stand to gain from using a boutique broker since they may be more willing to allow you to buy pre-ICO shares. But there are cases where large firms may disallow first investments to be in IPOs. And if an individual is able to invest in, then they may be wealthy investors with reputation.

Show Caution

You may have a burning desire to dive into the IPO market immediately, but take a breathe and show some level of caution. Uncertainties surrounding the outcome of these investments make it needful to be cautious. And even more so, if a broker has recommended an IPO to you.

In the case of the latter, it may be an IPO institutional investors are uninterested in. Hence, the offer may be passed to retail investors, and this is a sign that the IPO has little or no potential in yielding immense profit. Therefore, your broker’s recommendation may not stem from the fact that they want you to earn, but to sell a pitch.

Here’s something else to dwell on. Brokers may show favoritism by offering IPO shares to certain clients. Hence, it may not be easy for a regular investor to find an opportunity to purchase the shares. This means that if you’re suddenly offered an investment opportunity on a platter of gold, you’d better think twice before taking it.

Wait for the End of the Lock-Up Period

There is a lockup period for stocks to be held by private investors. It is legally mandatory for these parties not to sell their shares within the lockup period. And this means even if the price of the stock surges, they will still have to hold it.

Alternatively, you may be blindsided by the surge in the stock’s price to buy-in. But then, it is better to wait till after the lockup period has elapsed. After the period, private investors are free to sell their stocks, which could do a number of the stock’s price.

In contrast, if these investors still hold on to their stock after the period has elapsed, it goes to show their confidence in the company, and belief for a more promising future. Then you can make your entry.

Is It Really the Best IPO? Questions You Need to Answer Beforehand

There are certain questions you need to ask before investing in an IPO. These questions help you to determine the potential of an IPO. Accordingly, consider the following:

Is the Company Stable?

Here’s the part where you need to fall back on the company’s prospectus. It’ll give you an idea of whether it is stable based on its revenue and earnings over the past few years. Therefore, consider whether your investment will be going into a growing company or one that is struggling.

How Much are the Stocks Worth?

The price of a company’s stock when it hits the market is an important factor to consider. The price range at which these stocks will be sold may be disclosed by the company in its prospectus. And the latter is often revised when the IPO is close. Asides from the price, it’s also useful to consider the valuation of the company.

Do Management Have Shares?

The company’s prospectus reveals the payment system set up for the management. Professional investors often settle for IPOs from companies whose management has a larger holding of the stock. The latter is evidence that management is a firm believer in the company’s future.

What Will the Cash be Used For?

Of what use will your money and those gathered from other investors be put to? That’s another question to ask. Good use of the raised funds is in an area such as expansion instead of paying private investors who want to sell their shares.

Conclusion

These are the easy steps on how to choose the best IPO to invest in. Following the tips outlined above will guide you on choosing a company with the highest potential to yield profit.

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