Whether it be your sister, father, aunt, uncle, or even yourself, everyone seems to know of a story about how they *almost* got rich. Often times it boils down to an individual almost investing their money in Apple or Tesla when they went public, but instead choosing a different company. This contributes to a hindsight bias and regret. However, there is some degree of method to the madness of investing. So, in order to fulfill one’s dreams of accruing capital raking in the dough, there are a few important things to know about IPOs.
IPO stands for initial public offering. It is the process by which a company shifts from operating in a private market to a public one. It occurs when a company goes from “privately held to publicly traded by offering stock to the public for the first time” according to strategy analyst Ross Mayfield at Baird Private Wealth Management. IPOs are a mechanism by which companies can pay down debt, raise capital to finance their business, or make strategic acquisitions.
So then, how should an individual approach investing with IPOs? First it is crucial to obtain as much knowledge as possible about the new stock. This is a process known as due diligence. According to USA Today’s money column, “that means reading the detailed prospectus the company files with the Security and Exchange Commission, or SEC”. The key questions you must ask yourself include asking what they plan to do with the capital raised. Do they intend to pay for more acquisitions, hire more workers, or fund capital expenditures? Answering these questions will help to determine whether your investment is worthwhile and moreover more accurately predict whether the company will be successful.
An additional important question to ask is whether the offering price is understated, reasonable, or exaggerated. According to Megan Horneman, director of portfolio strategy at Verdence Capital Advisors, “understand the current market conditions, how the company is being valued, and what future growth looks like. Is there competition that could predict the future price?”
Even after investigating the company and completing due diligence, there remain risks. The riskiest move can be “buying high”. This occurs when “highly anticipated IPOs attract levels of interest and see their price bid up rapidly in early trading, often well above reasonable levels.” As such it is most prudent to make investments in a diverse manner, this ensures that risk is distributed and not concentrated in one company.
Overall, IPOs are a great tool for growing wealth, but they must be utilized with concerted rationality and prudence.