Understanding IPOs

Initial Public Offerings (IPOs) are the first time a company sells its stock to the public. Sometimes IPOs make huge first-day gains like Chipotle Mexican Grill (CMG) which was offered at $22/share and ended their first day of trading at $44/share. Wow. However there are times when the market is overall bearish and the IPO will flop like in the case of Vonage Corp (VG) which was offered at $17/share but has now dropped to around $6.5/share.

Unfortunately more than ever individual investors dont get access to the stock at initial offered price. Its the mighty institutional investors who do. By the time the general public can trade the stock, most of its first-day gains have already been made. However, a knowledgable investor should still watch the IPO market, because this is the first opportunity to buy these stocks.

Reasons for an IPO
When a privately held company needs to raise additional capital, it can either take on debt or sell partial ownership. When the company decides to sell ownership to the general public, they engage in an IPO. The most common reason for the company to go public is that capital raised through an IPO does not have to be repaid, whereas debt securities such as bonds must be repaid with interest. In return the current owners of the privately held company will lose a part of their ownership.

The company will load the burden of the sale of its shares to the public by hiring an investment bank. Once the Securities and Exchange Commission (SEC) approves of the company’s profile, the investment bank and the company will decide on the price and date of the IPO; the IPO is then conducted on that date. IPOs are sometimes postponed or even withdrawn in poor market conditions.

So what can you as an individual investor do to make profit from IPO ?

  • Online brokerages offer IPO shares to their customers. Unfortunately, these shares tend to be reserved for clients with the largest balances (usually $100,000 and up), and are thus out of the reach of many investors. Most brokerages will not allow investors to sell IPO shares within a certain time period (generally 60-90 days), which prevents any short-term gains.
  • Buy carefully after they have become available to the general public. Institutional investors will not get as many shares as they want before the stock becomes available on the general public, thus, an individual investor can buy the stock as soon as its available, and count on the institutional investors to drive the price higher.
  • Sometimes the stock is priced too low than it should be. This would be a good time to buy.
So how do i know is the IPO overpriced or underpriced ?
  • As with any investment, proper education and careful research are vital to profiting from IPOs.
  • Business, financial, and market risk are few of the factors that should be included in the evaluation process.
    • Business risk = Examine the business model and the management team.
    • Financial risk = Examine the financial statements, capital structure, and other financial data.
    • Market risk = Examine current and future market conditions.
  • You should also inquire about the purpose of raising capital through an IPO. If the corporation were issuing an IPO just to get out of financial problems, is investing in this corporation a wise decision? On the other hand, if the company has some smart plans for the money, then the IPO might be justified.
Recommendations: One should understand that investing in an IPO can be risky business. The investor must thoroughly investigate all available information to understand the value of the stock. I personally like buying IPOs of well known brands. My personal favorite being MasterCard Incorporated (MA) which was offered at $40/share and is now trading at $105/share.

Other Good IPOs: CMG, DIVX, BKC
Coming soon good IPOs i like: Aruba Networks, US Auto Parts, Vanguard Car Rental, Sterlite Industries, Oculus Innovative Scis