Investing in an Initial Public Offer (IPO) can be a lucrative opportunity and at the same time, the investor can be in a dilemma whether to invest in an IPO or not.
IPOs can be a risky investment. For the individual investor, it is tough to predict what the stock will do on its initial day of trading and in the near future because there is often little historical data to use to analyze the company. Also, most IPOs are for companies that are going through a transitory growth period, which means that they are subject to additional uncertainty regarding their future values.
It is very difficult for a common retail investor to arrive at a basic value of a stock before putting money in an IPO. However, there are some factors which can very well prove to be productive in an IPO investment. Here are some key factors that you should consider before investing in an IPO.
Performance and Growth over the Years
Consider what has been the performance of the company in terms of profitability as well as the ‘year on year’ growth in profitability registered by the company. Also, consider whether the company has been able to register a growth in revenues over the years. Note that revenue growth is one of the most important factors to consider while determining whether an IPO is worth investing in.
Stage of the Company
Prior to all the factors, one should keep in mind the stage of the issuing company and if the company is stagnant or is it in a growing stage. This will give you a sense of whether it is a good idea to put your money in the IPO. Generally, investing in an IPO of a company which is in the growing stage is good, as one should be looking to invest in a company which has future growth prospects.
Existing Competition in the Market
An intelligent investor will come to know the future prospects of a company by looking at its core competitors who are currently listed on a stock exchange. One can come up with the stock price based on competitors’ stock price and then compare it with the price the company is issuing during the IPO. This way one can come up with a fair valuation based on competition and can figure out whether or not one should go ahead with the IPO.
See Also: Presenting the Four Stages of the Market
Utilization of the Proceeds
Before going to invest in an IPO, an investor should read the prospectus of the company carefully and should study all the necessary information mentioned there. An investor should also be aware of the purpose of the money and the planned use of the funds raised by the company. Once an investor is aware as to how the company plans to utilize the funds, it will give one confidence and clarity regarding if the funds raised will be utilized for the right purpose.
Company’s past performance clearly indicates how the company has performed over the years and is going to perform in the coming years. If the company’s growth chart is volatile, an investor should refrain from not investing in a particular company. However, if the company’s growth rate has been stable and growing over the years, there is a high chance that the company will do better down the road.
Management Analysis Report
No one knows the company’s insider information better than the management itself and the management discussion and an analysis report tell the whole story about the company. One should read the report with caution and should take the less positive notes about the company very seriously. If the management says that the growth cycle will slow down in a couple of years, then the investor should go on carefully before making an investment in the IPO.
A major indicator of investment in an IPO is the credit rating or the investment grades that the credit rating agencies give to an IPO before it goes public as the analysis done by these agencies are complete and the credit rating agencies have a dedicated team of experts who work to the best of their knowledge to come up with an investment grade for an IPO.
Future Outlook for the Industry
Future outlook of the industry in which the company is operating is an important factor to consider while determining whether to invest in an IPO. A country’s demographic structure, its economic and political environment as well as its laws and regulations have a significant impact on the future outlook of any industry.
A firm may be managed by the best. But if it operates within an industry where opportunities are limited, its growth can at best be moderate.
An investor has to have a complete look at their other investment alternatives that can provide them with higher and more worthy returns. It is not necessary to invest in an IPO as you always have an option to buy it from the secondary market so it’s good to evaluate other funds and stocks which may be safer and might give better returns than investing in an IPO.
These are not the only factors that can be looked into before going to subscribe an IPO, one should trust the management and the company’s product more than the issuing price because if the company is fundamentally strong, it can gain value on its share with can, later on, prove to be a good investment.
IPO’s can be attractive investment bets provided you do your research and invest right. It would be better to do your own research rather than blindly follow your broker’s advice while investing in an IPO.
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