Investing in an IPO - good idea or a bad one?
An initial public offering, or IPO, is the very first sale of
stock issued by a company to the public. Prior to an IPO, the company is considered
private with a relatively small number of shareholders made up primarily of early
investors (such as the founders, their families, and friends) and professional investors
(such as venture capitalists or angel investors).
- The growth opportunity for the company in the sector and industry it operates and how the
share price of similar companies performed in the past
An overflow of Initial Public Offerings (IPOs) hit the market when the market is in an
upward direction (bull run) and investors clamour to subscribe to most of these IPOs,
hoping to make a kill on listing. However, IPO investors don’t always make a profit as has
been proven time and again. In fact, in many of the IPOs, investors have suffered huge
losses. Nevertheless, the herd mentality of the investors drives them to subscribe to
IPOs. Of course, there is no denying the fact that there have been many IPOs that have
given investors huge returns in the past, but these are more of honourable exceptions
rather than a rule. The fact remains that most of the IPOs provide negative returns when
markets have gone into a downward phase (bear run).
Some key things that an investor should look for before jumping into the IPO:
- The reason behind raising the funds through IPO. If it is for supporting the future
growth, that is a good indicator. However, if it is to cash out existing shareholder, then
it should be treated with degree of caution
- The people behind the company and their track record. It is important to know how involved
the founders will be in the future as they will be the main driving force and, in most
cases, not a new hot shot CEO or new management that will come in.
Therefore, investors should not simply chase the IPOs blindly, but must be picky while
subscribing to the IPOs. They need to do their homework and subscribe only to the IPOs of
the companies that have a great business model, are fundamentally sound and in good
financial health. Only then, can they expect to get good returns on their investments.