Introduction
Getting a chance to invest in an IPO is always a good thing since it would always attract more investors due to the various good results that an IPO has but then again like any Investment it always has its risks. IPOs are the first time a company offers its shares to the public and even though it comes with the opportunity of investing in a good company from its early stage, it comes with high risks. Here are some of the best practices that one should take while investing IPO in order not to lose his or her money. Here, the author shall provide some simple strategies that will help the investor to avoid losses when investing in an IPO.
Table of Contents
Research the Company Thoroughly
One research done was to find out some of the common mistakes that investors make especially in the IPOs, and one common mistake was participating in an IPO with little knowledge of the company involved. It will be wise you learn about the company’s financials, its operations, competition, and future revenue generation ability before investing your hard-earned money.
- Read the Prospectus: The prospectus is a document that the company intends to go public files before going public. Such specific information includes the company’s past and future performance, prospects, vulnerabilities, and how the IPO fund will be utilized. This paper will seek to compare and contrast the prospects between the two companies so that you determine whether the particular company is a good long-term investment.
- Understand the Business Model: This is important in understanding whether the business model of the company is viable in the long run to sustain the growth of the company and also generate good returns. For instance, the firms in the growth industries, for example, technology have great growth prospects, however, at the same time, great rivalry.
- Check the Promoters’ Background: Firstly, one has the see the reputation and previous experience of the firm’s promoters or founders. If they have been involved in any business, were the businesses successful or did they occur in the ventures which are considered to have been flopped? From the analysis, it can be deduced that having a strong leadership team is usually a signal of high performance.
Evaluate Market Sentiment
Market sentiment therefore has a very big influence on the performance of an IPO. In some cases, a company finds itself in the middle of much media attention and the stock rises soon after the attention is given but afterward, the stocks fall drastically. Concerning the given IPO, it would be possible to quantify the market sentiment, and investor interest to determine whether the IPO is good or it is just hype.
- Avoid the Hype: An IPO that has just come to the market does not necessarily which has come into the market is not a sure shot hit. After listing, many firms overall underperform in expectation of the hype that is created. Concentration on the value and not on the enthusiasm and glamour.
- Look at Recent IPO Trends: Comparing the performance of IPO firms across industries and in industries similar to the one that the IPO you are interested in belongs to can help you have an idea of the success of the intended IPO. If most of the recent IPOs are below average, then it is a sign that the market is not friendly.
Timing Is Critical
The time of investment in an IPO can play an important role in the expected returns. The timing of entry into the markets has the potential to have a big influence on the returns earned by a business.
- Consider the Market Cycle: performance is higher when the lifecycle of the stock is in its bull phase assuming the market is in the IPO phase. However, during the bear runs or during periods of economic downturns even the most promising IPO firms may not perform so well.
- Avoid IPOs During Market Bubbles: If for instance, you discover that many firms are floating in the stock market within a short span, then this must be an indication of a market bubble. They can risk their money by investing in IPOs especially when the event is going on as the prices may plummet.
Analyze the Valuation
Such losses are ill-favored in an IPO; therefore, valuation is crucial when it comes to minimizing such incidences. Many a time, the IPO shares are offered at a theme that is thought to be based on its projected growth rate, however, this price could be an over-inflated one.
- Compare with Peers: Check how the valuations made in the IPO compare with each of the other companies in the industry. If the valuation is high compared to its competitors, then there can be a problem in such a case. A reasonable valuation assures an extra cover for investors against potential excessive risks in the market.
- Understand Price-to-Earnings (P/E) Ratio: One of the easiest methods to evaluate valuation is by performing the price-earnings ratio test otherwise referred to as the P/E ratio test. The ratio refers to the future growth in a company, a higher P/E ratio means that it has high expectations of growth and equally high risk. Ensure that the P/E ratio is appropriate depending on the company’s growth prospects.
Diversify Your Investments
Risk diversification is perhaps one of the most significant considerations when it comes to cutting on risks when dealing especially in the IPO market. When you diversify your portfolio, what this means is that assuming that there is a given IPO that is not doing well, other sectors or other types of companies in your portfolio will likely do well and hence the overall impact of a given IPO will not be very big on your overall portfolio.
- Don’t Put All Your Money Into One IPO: If you think that an IPO has a real future – it is unadvisable to invest more than 10-15% of your capital into a single stock. Volatility is evil, thus, by diversifying the portfolio, the variability of returns is minimized.
- Consider Other Types of Investments: To minimize risks, you may also diversify them with such investments as bonds, mutual funds, or blue-sky stocks. In this respect, no matter how poorly the IPO investment performs, other stocks will hold the investors’ portfolios average.
Understand the Lock-up Period
The lock-up period is a particular period after the IPO process that is provided to the executives of the company, early investors, and other significant shareholders in which they cannot sell their shares. After this restrictive period elapses, these insiders might be inclined to sell out shares and this affects the prices of the stocks in the market.
- Monitor the Lock-up Expiry: From these, it becomes apparent that one should look out for when the lock-up period elapses as this may result in an increased supply of shares in the market thus controlling the share price. In the case of having some shares in hand, then it may be advisable to sell before unlocking.
- Be Aware of Insider Activity: However, when several corporate officers and directors dispose of their stocks in large quantities after the expiration of the lock-up period, this may be interpreted as having low confidence in the corporation. On the other hand, if insiders have retained the shares then there may be a good prospect of good performance of the share.
Assess Long-Term Growth Potential
What can help to avoid loss while investing in an IPO is to avoid thinking about it in terms of how much one would gain in the short run but how much the company in question would be worth in the future. Successful IPO investments can sometimes be time-consuming and therefore one has to have a long-term perspective of the investment.
- Look at the Industry Outlook: One may ask oneself is our company likely to operate in an industry that will expand in the future years. For instance, companies that are in technological-related sectors like artificial intelligence, cloud computing, or renewable energy sources may be considered to have better long-term outlooks than companies that are in outdated sectors.
- Focus on Innovation and Competitive Edge: Thus, corporate success is possible if a company has a unique product or service on the market and has a competitive advantage. Ensure that the company is not compromising on the sector trends but stands to be among the sector leaders.
Learn About The Flipping Business And Some Of The Flipping IPO Companies
Some investors put their money in an initial public offer which is to “trade” the company’s shares at the initial offer price to make money out of it. Although this approach can be effective to some extent it is also very aggressive and can result in loss making.
- Volatility in the Early Days: IPO stocks such as the ones listed in the market are often very sensitive in the first few days because if the market turns against you, then you are stuck with the stock and it becomes very difficult to get some of the stocks and ends up selling at a loss. This is because patience is so often rewarded in quality stocks rather than the attempt at a smart trading exercise which may only result in quick losses.
- Avoid Emotional Decisions: The zeal that accompanies an IPO results in high emotionality which can lead to irrational investor decisions. Stay disciplined and do not let yourself be carried away by the social hype of the market.
Conclusion
IPOs are a good investment but it needs to be done in a proper manner involving a lot of research and willing to have patience. To avoid getting burnt with these new IPO’s, you should therefore ensure that you familiarize yourself with the fundamentals of the company that you are considering investing in, watch the market sentiment, and ensure that your investment is reasonably priced. Other strategies include diversification of investment, understanding and avoiding the lock-up period, and concentration on long term return than on short-term risks.
It is important to understand that not all IPOs are going to be successful and it’s important for investors not to get caught up in the hype of getting instant returns. It is therefore important to maintain a clear investment strategy and get as much information as you can to make balanced and competent decisions in the complex IPO market.
