It is eminently possible to get caught up in the excitement of IPOs (Initial Public Offering). Uninformed people think it’s an easy way to make money. They believe listing gains from IPOs are almost inevitable. This is far from true.
You can lose money if you don’t think before you invest in an IPO. This can happen again and again and again. Just like with any other investment, it’s important to do your homework and review some IPO basics. This will ensure that education, not hype, drives your decision-making.
No investment is a sure thing. When evaluating an IPO, it is prudent to shift the focus from aiming to make a quick buck to the long-term outlook. Rather than trying to capitalize on a stock’s initial bounce, investors would be well advised to carefully scrutinize long-term prospects and keep a price point or points at which they should monetize their investment. Don’t be greedy. It can lead to heartbreak and negative consequences that are unpredictable.
That said, even if you have a longer-term focus, finding a good IPO is difficult. Direct equity is a different ball game. It’s riskier than investing in mutual funds. What’s more, IPOs have many unique risks that make them different from average stock or other investments. Here are 5 checks you must carry out before you fork out money for an IPO.
Remember that although most companies try to fully disclose all information in their prospectus, it is still written by them and not by an unbiased third party.
Search online for
information on the company and its competitors, financing, past press
releases, as well as overall industry health. Learning as much as you can about the company is a
crucial step in making a wise investment.
Always Read the Prospectus. While
you shouldn’t take everything that is in the prospectus at face value, you should
never skip reading the prospectus. It may be a dry read, but
the prospectus lays out the company’s risks and opportunities, along with the
proposed uses for the money raised by the IPO.
For example, if the money is going to repay loans, or buy the equity from founders or private investors, then look out! It is a bad sign if the company cannot afford to repay its loans without issuing stock. Money that is going toward research, marketing or expanding into new markets paints a better picture.
One of the biggest things to be on the lookout for while reading a
prospectus is an overly optimistic future earnings outlook; this means reading
the projected accounting figures carefully.
Skepticism is a positive attribute to cultivate in the
IPO market. It is worth reiterating here that there is always a lot of uncertainty
surrounding IPOs, mainly because of the lack of available information.
Therefore, you should always approach an IPO with caution. If your broker
recommends an IPO, you should exercise increased caution.
Don’t’ borrow money to invest in an IPO. No
matter how prestigious or well-spoken, an IPO is not a fool-proof way to make
money. Never borrow money to invest in an IPO. Doing so is akin to borrowing
money to gamble. The risks of doing so are obvious and definitely avoidable.
There are much more secure ways to invest. A good investment advisor will tell
you about them.
The Bottom Line
When
it comes to dealing with the IPO market, a skeptical and informed investor is
likely to perform much better than one who is not.