How to Approach an IPO

Investing in a newly public company can prove difficult for many inexperienced investors, according to The Associated Press. But some basic tips can help prepare people for what to expect.

The biggest difficulty for most initial public offerings is that for companies just going public there is no open record of their finances to this point. Even with long-established companies, it can be difficult to know much about revenue, costs and profits without explicit financial releases.

The track record for IPOs of late has proven generally poor as well, with more than half of all newly public companies this year trading below their initial offering prices. Of course, anyone investing in an IPO must understand that the chances of losses are relatively strong for most companies, in part because prices rise so quickly with the early surge of demand but also because of the volatility in the wake of this frenzy.

In general, people pay substantially more in the first few days after an IPO than in the weeks following, on average about 11 percent higher when they first hit the open market. Those purchasing directly from the company will also face their own costs, as that is generally impossible without a brokerage account with one of the banks conducting the IPO, the so-called underwriter. These banks impose a variety of rules in order to participate in an IPO, generally designed to target specific clientele, and individual investors must investigate these requirements carefully in the lead up to the desired IPO.

“It’s a rigged game,” David Menlow, president of IPOfn Financial Network, told the AP. “Underwriters rule the roost, and they make the rules for who they’re going to do business with.”

Of course, this highlights another of the major keys: understanding the IPO market itself. This industry utilizes a large number of specialized terms that can be lost on newcomers. Learning to read the actual meanings of terms like underwriter, aftermarket – the share available on the exchange after the IPO – and a “greenshoe option” – an allowance for selling extra shares given high demand – can prove the difference between a profit and a loss.

Of course understanding the market from the company’s perspective is also important. The AP notes that investors should look to companies with high sales and declining costs, a longer pedigree or hopefully profits. Yet CNN notes that companies have many ways of presenting their financials more positively before an IPO than they would appear normally. This can prove difficult for a company, which will quickly come under unreasonable expectations, but the temptation for a dramatic IPO can often prove overwhelming.

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