Initial Public Offerings are means by which a company can raise debt free capital through sharing the ownership and profits. When anyone chooses to invest in IPO, it must be taken into account that it has certain merits and demerits.
The golden rule of investment is higher the risk, higher the return. IPOs have many risks that make them different from the average stock that has been trading for a while. Thus, there are some factors to be considered when investing in an IPO that can minimise the risk involved.
Basics of IPO
When the company starts growing, there is a time when it requires huge capital to take it to the next level of growth. Some companies opt for profit sharing and others decide to raise debt to get this capital. Another alternative is the IPO route. When investing in an IPO bear in mind you are opting for part of its losses and profits too. Thus, one needs to be very choosy on which companies you want to invest in.
Risk factors involved when investing in IPO
Market risk: It is sensible to check the demand for the IPO in the market. Check out the appeal of the IPO to other investors in the market. Thus, researching market risk involves examining the appeal of the corporation to current and future market conditions.
Financial risk: Does the company have enough funds to bear short-term business obstacles? It is important to consider the liquidity position of the company. Thus, researching financial risks includes analyzing the company’s financial statements, capital structure and such financial information.
Business risk: It is very important to note if the firm has sound business and management policies that are in line with standard norms. Researching business risk involves inquiring about the business model of the company.
Potential of the stock market: Stock markets, being subject to high volatility, investments in an IPO do not guarantee returns. The fluctuations in the market affect the entire economy including the individuals and households. Due to this volatility it is not easy to predict how the share will perform over a period of time as profit and the risk potential of the IPO is dependent on the condition of the markets at that particular time.
No previous track record of the company: The shareholders can get into a tight spot in deciding whether or not to invest in that IPO as the company’s track record is not available. There is no basis for making any investment decision in the absence of track record.
Unpredictable: Unpredictability of IPOs is the main reason why investment advisers ask investors to stay away from IPOs. The shares are usually offered at lower prices, but we see major changes during the day they will be offered. There are possibilities that they may rise sharply during that day and then fall steeply the next day.
Ways to minimize risks when investing in IPOs
Studying the company
A good way to begin your IPO analysis is to look at financial reports of the company for as many years as possible. Also look at the difference in the assets value and debt which in effect is like the company value. Check what is the effective company value based on the IPO price and number of shares. If the IPO price is less than this value you are in for good profits on listing.
Picking the right IPO
Research thoroughly on how the company is planning to use the money raised through IPOs. Some companies may use it to pay off their debts. Companies that issue IPOs to repay their loans cannot boast of healthy growth potential. Others may use it for expansion, research and marketing. With very little expert analysis to rely on, investors must adopt a cautious move. If you can pick the IPOs right, they are an easy means to make quick money.
Analysis of some IPO performances
The behavior of IPO after their initial listing has been mixed. Some IPOs have done well while others have failed. In the recent Bull Run, most IPOs have fared well. When it comes to IPOs always invest with caution.
An industry expert says, “The right recipe is to go step by step with each step dependent on the other. If you miss out one step the whole structure will disintegrate. IPOs are considered as risky investments but these risks can be reduced with careful analysis. As long as you do your research, the risks are less.
