Initial public offerings, or IPOs, are considered riskier than the rest of the stock market because there is lot of uncertainty attached to them. It is hard to predict the right price of an IPO stock, but understanding the market fundamentals will help you make money out of these opportunities. And if you get it right, investing in IPOs can be extremely profitable.
IPOs are usually subject to attractive initial valuation so that enough investors subscribe to the offer. That is why they can see a significant price rise when they start trading on the second market. But the opposite can also be true sometimes. When an IPO fails to attract sufficient investor interest, its price can see a steep decline on the first day itself.
Company’s prospects
Do not just invest in an IPO just because brokers are strongly pitching the offer. Background research about the company is essential to make a wise investment. Gather information about various aspects of the company’s business, such as competitors, financing, past press releases, as well as overall health of the industry. This is very important, as sometimes the company’s prospects might be overrated.
Carefully consider the product lines and management stability of the company that is launching the IPO. High quality products and services, and responsiveness to changing consumer preferences ensure a stable business for the company. New product development draws further investor interest as it shows that the company has solid future plans to grow its business. Stability of management shows that the company is doing well and its leadership has faith in its prospects.
Reputation of underwriters
Quality and reputation of banks underwriting the IPO is also an important consideration. Establish investment banks such as Goldman Sachs and Credit Suisse usually support only good companies as they can afford to be choosy about the companies they underwrite. On the other hand, small banks are usually willing to underwrite any company. You should also look at whether any large financial institutions have disclosed their interest in the company and which VC funds supported the company in its initial stages.
Finally, you should not forget about the current state of the economy and investor interest in the stock market before subscribing to an IPO. When the economy is bad, most people shy away from such offers and there’s very little chance that you’ll see a significant appreciation in the price. Stay away from the IPO if this is the case, as you can always pick up the stock from the secondary market at a later stage.
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