What is an IPO and how to participate in an IPO?
What is an IPO in simple words? How to participate in IPO? How to make money on investing in IPO? You will find answers to these and other questions in our article.
Hello, gentlemen, traders and investors! Today we will talk about investing in IPOs, what it is like to participate in an IPO, how IPO differs from traditional stock trading on the stock exchange, how to choose reliable IPO companies and how to protect your investments from possible risks.
See also a review of the best broker Freedom Finance with IPO trading.
IPO - what is it in simple words
Initial Public Offering (IPO) is the initial public offering of a company's shares on a stock exchange. Previously, the company distributed its shares to a narrow circle of investors, but with access to an IPO, it already offers shares to an unlimited number of investors and becomes a public company.
Reasons for IPO
- Raising capital. Thanks to the IPO, the company gets access to the maximum number of investors, and instead of borrowing money, it offers its share in the business. In addition, the procedure for obtaining loans from banks is simplified, since the company is public, and all information on financial statements becomes open;
- Obtaining an independent appraisal. The stock price of a company is the most accurate measure of its success. Trading on the exchange makes the company more popular, and also helps in promoting its products or services;
- Paying profits to first investors. Venture capital investors specializing in startup investments make a profit by selling shares to new investors, which gives them the opportunity to invest in other start-up companies.
Stages of an IPO
- Preparation for participation in the IPO. At this stage, work is carried out to develop a company’s strategy, analyze financial statements, bring documents in accordance with the standards and requirements of regulatory authorities. Putting your shares on the stock exchange is not so easy as there are various financial commissions (for example, SEC - the US Securities and Exchange Commission) that make certain demands on companies. The companies also create an investment memorandum in which they indicate basic information about the company, the estimated value of shares and the amount of dividends;
- Search for underwriters. Underwriters are investment banks that act as intermediaries between a company and a stock exchange. They invest their funds in the company before the start of the IPO and earn on the difference in the value of shares before and after the IPO;
- Advertising campaign. Next is Roadshow - the company's management talks about its product and investment prospects for potential investors. This can be advertising on the Internet and on TV, personal meetings and presentations, etc. Then the collection of applications from investors begins, which indicate how many shares they are willing to buy;
- Choice of the exchange. As a rule, IPOs are held on well-known stock exchanges. For example, in the USA these are NASDAQ, NYSE and LSE, and in Russia - RTS, MICEX and SPBV. Investment companies are usually used to buy shares before the stage of their placement on the stock exchange, the so-called pre-IPO;
- IPO. This is the last stage when the nominal price per share is determined, and the shares themselves go to the exchange and trading begins. In the early days, the stock price can jump very much, but then the price is gradually adjusted.
Let's imagine that you have a certain amount, for example, $ 10,000 that you want to increase. You can put money in the bank at interest - an average of 1.5% per annum on dollar deposits. Thus, in a year you will receive $ 10,150 without risk of losing your investments.
If your goal is not to save funds, but to increase them, then you can buy shares of large companies on the stock exchange. For such well-known brands as Google, Apple, Amazon and other companies, the long-term trend is growing, so in the future you can get good income, but you should not count on big dividends - usually they make up no more than 2-3% of investments. But here there are pitfalls. When buying stocks, you can fall into a period of drawdowns, which can take years to exit.
For example, Apple shares in 2017 rose 46% for the first time since the 2008 crisis. Those who bought Apple shares at the bottom of the crisis received a yield of 39% per annum. However, those who bought the shares of a well-known company before the crisis had to wait 2 years to go to zero. Thus, the success of an investment depends on a successful entry point. The most profitable, but also risky, is the purchase of shares at the height of the crisis, then it will be possible to get the highest profitability at the time of the heyday of the company.
Investments in IPOs are a little more risky than stock trading, but the yield on them can exceed 10 times the purchase of shares in the secondary market and 30 times the percentage on bank deposits. As a rule, stocks begin to grow immediately after their placement on the stock exchange. Let's take a closer look at how to participate in an IPO and how to protect yourself from possible risks.
See also list of the most reliable brokers.
- Choosing a broker. First you need to find a broker that provides the opportunity to participate in the IPO. Brokers select the most promising IPO companies and offer them to their clients;
- Examining information about a company participating in an IPO. The main reason investors fail in an IPO is the lack of analysis of company information. This is a big mistake. You should carefully study all the information that you can find, starting from brochures, and ending with financial reports and reviews of other investors. Also find information about the underwriter - an investment bank that puts the company in an IPO. Large banks will not work with little-known and unpromising companies;
- Risk diversification. Do not invest all your money in one IPO. Divide your capital into at least three parts and invest them in different IPOs. In this case, even if your funds are frozen during the lock-up period, you can always invest the remaining money in new projects;
- Filing an application for participation in an IPO. After you have selected a company as an object of participation in an IPO, you need to fund your broker account and submit an application in which you must indicate how much want to buy stocks. As a rule, the application is partially satisfied. For example, if you filed an application for $ 10,000, then most likely you will receive a block of shares in the amount of $ 7,000 - $ 8,000;
- Start of bidding. Most IPOs bring 60-70% of the profit, but there are companies that fail, then you get back about 30% of the investment. There are few such companies, but in order not to lose your investments, carefully study the information about the company and distribute funds for different IPOs. The offering price of shares is not known in advance, but usually on the first day the shares soar, and then the price for them begins to decline slowly until the stock price becomes stable;
- Profit taking. Investors cannot take profits until the lock-up period ends. During this period, investors cannot sell their shares. This is done so that there is no speculation at the beginning of IPO trading. The term is specified in the contract and usually ranges from 90 to 180 days.
See also what brokers with a banking license exist.
IPO Participation Example
For example, you learned from your broker that a certain company X is going to launch an IPO on May 1, 2019. You have $ 30,000, and you decide to take part in an IPO for 1/3 of this amount, that is, $ 10,000. Company X placed shares at $ 25. Since the demand for shares of this company was high, your application was 60% satisfied, that is, you bought 240 shares in the amount of $ 6,000, and the remaining $ 4,000 returned to your account.
On May 1, 2019, trading on the stock exchange was launched, and the stock price rose to $ 38, then the shares fell to $ 33. To sell shares of this company, you need to wait until the end of the lock-up period, which is three months.
On August 1, 2019, the lock-up period has ended, now you can sell shares of company X. Suppose that stock prices remained at the same level - $ 33. In this case, the profit will be 240 × 33 $ - 6000 $ = 1920 $. The broker usually takes an entrance fee of 3%, an exit commission of 1.75% and a profit commission of 20%. Excluding all commissions, your profit would be 1920 - (6000 × 3% + 7920 × 1.75% + 1920 × 20%) = 1920 - (180 + 138.6 + 384) = $ 1217.4. Thus, your net income for 3 months was 20%.
After some time, investors can sell their shares without waiting for the lock-up period to end, paying a 10% commission to the broker. In this case, investors will be protected from a possible fall in the stock price, but profit will be noticeably reduced. We recommend that you wait until the end of the lock-up period, as practice shows, such transactions bring more profit.
See also what FORTS brokers are.
How to protect yourself from risks while participating in an IPO?
Investments in IPOs can bring tens of percent of profits, but finding a company that already on the first day of trading on the stock exchange would cause investors to get excited is not so simple. So, if we compare the statistics of successful IPOs on the NASDAQ exchange, then 74% of new offerings grow in value on the first day of trading. After a month of trading, positive dynamics is maintained in 69% of companies. The number of companies whose shares on the first day of trading grow from 10% and higher is not more than 28%. So finding an IPO that “shoots” on the first day of placement on the exchange can be much more difficult than it seems at first glance. To become a successful investor in an IPO, the following criteria must be considered:
- Industry affiliation of the company. It is best to choose fast-growing innovative companies related to IT, electronics, genetic engineering, biotechnology, etc. These industries are the most promising in 2019. Such companies have greater growth potential than traditional industries;
- Growth potential of the company. Many investors are prepared to suffer losses in the first months and even years of the company’s work, as they are confident in the great growth potential and successful business model of the company, which can make them rich in the long term thanks to innovative developments demanded in the market;
- Company reputation. The most attractive for investors are well-known companies with a high reputation in the market. Such companies usually have public reporting with a good trading history in the form of borrowed funds in the form of bonds. A company may have a recognizable brand that you may have seen in advertising or in the news. She should not have high-profile legal scandals and proceedings. Another positive criterion is the participation of venture investors such as Sequoia, Tigers or Tencent, their presence is considered a quality mark for retail investors;
- Placement of shares. Statistics show that the initial placement of shares on US exchanges is the key to success. The thing is that the US stock market is the most liquid and has effective regulation;
- Work of the IPO organizers. Before investing, you need to study the effectiveness of the underwriters who put the company in IPO. If they managed to bring various companies to the stock market earlier, they attracted large capital of investors, and their shares did not slide down immediately after the start of trading, that is, there is a big chance that this company will succeed.
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Thus, Initial Public Offering (IPO) is an initial public offering on a stock exchange. The company goes into IPO to attract capital and new investors. Stock prices are usually underestimated by 30% before going public, so this is a great opportunity to make money. However, it is worth remembering the lock-up period during which shares cannot be sold, and the possible risks of investing in an IPO. So, one should not invest in the latest and, especially, borrowed funds, it is necessary to diversify risks, and choose companies according to the rules described above. In this case, participation in an IPO will allow you to get high returns, which are several times higher than the profits from traditional stock trading on the stock exchange and ten times higher returns on bank deposits.
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