Investing in IPOs is not an easy matter, and there are a lot of precautions to remember before you can commit your money into this venture.
Research about the Company
Trying to acquire information about companies who are going public is not easy. Private companies do not usually have a bunch of analysts trying to determine the company’s strength and financial status. Bear in mind that even though companies try to fully disclose all information in the so-called prospectus, it’s still them who wrote it and not an unbiased third party.
You can give searching online a go, finding further info about the company, its rivals, financing, press releases, and other relevant data. Remember that you are going to invest your money in that company, so you better know what you’re getting into.
As much as you can, try to pick a company that has a strong underwriter, as quality brokers usually bring quality companies public. When selecting smaller brokerages, you need to be extra careful, since such may be willing to underwrite just any company.
On the other hand, smaller brokers make it easier for individual investors to buy pre-IPO shares because of their smaller clientele.
Also, keep in mind that most big brokerages do not allow your first investment to be an IPO. That kind of feature is usually reserved for long-standing, established, high net worth clients.
Read the Prospectus
Although it may be biased toward the company, never skip the prospectus. It’s boring, yes, but the prospectus tells you something about the company’s risks and opportunities. You will also know where the company intends to use the money they raise in the IPO.
When reading about where the money is going, you need to be wary of overpromising companies. They usually end up underdelivering. Overly optimistic future earnings are a red flag.
You may try to search for companies that plan to use money for better purposes, such as research, marketing, and expanding to new markets.
Take Information with a Tubful of Salt
It is prudent to be skeptical when it comes to IPOs. There is always a lot of uncertainty, merely because information is scarce. That means it pays to approach IPOs with more than a grain of salt.
For instance, if your broker recommends an IPO, be extra careful. Typical in this situation is the investor is getting the bottom feed, which are the leftovers that the high rollers didn’t want.
On top of that, even if you find a company going public which you think will be a worthy investment, it’s possible that you won’t be getting the shares. Brokers tend to save their IPO allocations for favored clients.
Wait for the Lock-up Period to End
The lock-up period refers to a legally binding contract between the underwriters and insiders of the company prohibiting them from selling any shares of the stock for a specified period, which is usually 3 to 24 months).
Waiting until insiders are free to sell their shares is not a bad strategy. That’s because if they continue to hold stock once the lock-up period is over, you may treat it as an indication that the company has a bright and sustainable future.