How To Invest in Initial Public Offerings

Investing in Initial Public Offerings for Beginners

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An initial public offering (IPO) is when a company first sells shares to the public. It is the first opportunity that everyday investors have to buy shares in a private company that is going public.

Going through an IPO is an exciting time for a business, as it uses IPOs to raise money for future projects and expansion. The process can also be an exciting time for investors, as they can buy shares during the initial public offering and be among the first people to have a stake in a young company. 

If you’re interested in investing in IPOs, learn how and if you can do so, as well as what the process looks like.

How To Invest in IPOs in 4 Steps

If you choose to invest in IPOs, there is a step-by-step process you can follow.

Decide Which Public Offerings To Buy

If you want to invest in an IPO, the first thing you need to do is figure out which company you want to buy shares in. Many stock exchanges maintain a list of the companies that have filed to IPO and the dates on which they are expected to go public. You can use these listings to choose a company to invest in.

Choose How To Invest

There are two ways for investors to get involved with an IPO.

The first is to be a client of the company underwriting the IPO. If this is the case, the underwriter may give you the option to purchase shares directly from the company going public at the offered price. 

Having the ability to purchase shares directly from a company going public at the offering price is usually restricted to institutional investors and high-net-worth individuals. Generally, it is rare for a typical investor to be able to directly buy in a popular IPO.

More commonly, investors will buy shares that are being resold by other investors on the day of the IPO, or on the days after the IPO.

Open a Brokerage Account

If you want to buy investments of almost any kind, you’ll need to have a brokerage account. There are many companies that offer brokerage accounts, so take the time to shop around and find the one that has the best offering for your needs.

Look at factors like minimum investments and commissions. If you’re targeting a specific IPO, some brokers may be able to get you involved directly instead of leaving you to buy shares from other investors, which may guide your choice of broker.

Submit a Buy Order

If you’re buying shares in an IPO from other investors, all you have to do is submit a buy order. Tell your broker how many shares to purchase and your broker will buy the shares on your behalf.

Because shares can be volatile immediately after an IPO, you may want to use a limit order, which sets a maximum price you’re willing to pay for shares.

What You Need To Know Before You Invest in IPOs

Initial public offerings can be exciting for investors, but it’s important to be aware of the risks. Some of the most volatile times for a stock’s price come immediately after the company first goes public. That being said, many companies see stock prices soar above their offering price soon after they first go public, so investors who buy shares early have the chance to see significant gains.

Understand the Risks of Investing in Initial Public Offerings

IPOs have a number of risks that investors need to be aware of.

  • Volatility: Investors who buy shares in an IPO need to be ready for large swings in the stock’s value. It may take a long time for the stock’s price to recover, if it recovers at all, to the point where you can sell it for a profit.
  • Unpredictable long-term returns: Long-term returns from IPOs can also be unpredictable. An April 2021 study conducted by Nasdaq studied IPO gains. It found that three years out from their IPO, roughly 29% of companies are beating the market by more than 10%, but 64% of companies are trailing the market by more than 10%.
  • Bias toward high initial pricing: When businesses go public, the IPO underwriters benefit from making the initial price of a stock high because it means raising more money. This can cause IPOs to be priced higher than they should be.
  • Sales by existing shareholders: People who owned shares in the business before it went public may want to sell some or all of their shares during the IPO. This can cause downward pressure on the stock price.
  • Low volume: Newly public companies may have a limited supply of shares available on the public market and it can take time for the trade volume to increase. This may make it hard to buy or sell shares when you want to, or for the market to find a fair price for shares.
  • Reduced reporting requirements: Many businesses going through an IPO are smaller businesses or startups. That means that they are exempt from some of the reporting requirements that larger businesses need to meet when it comes to releasing the business's financial information to the public. This can make it more difficult to research the company and determine a fair price.

IPO investors also need to accept the risks inherent in investing in stocks, including the potential to lose some or all of your money and having to deal with things like capital gains taxes when selling shares.

The Pros and Cons of Investing in Initial Public Offerings

Pros
  • Have the chance to invest in a company before many other investors

  • IPOs often gain value early on

Cons
  • Most investors don’t get direct access to IPOs

  • The majority of IPOs underperform the market after three years

Pros Explained

  • Have the chance to invest in a company before many other investors: One of the things that make IPOs exciting is that you get to buy shares in a company before many others have that opportunity. If the company is successful in the long run and you choose to hold onto your shares, you can make a significant profit. 
  • IPOs often gain value early on: Many companies see their share price jump quickly above the IPO price, giving early investors a chance for quick profits.

Cons Explained

  • Most investors don’t get direct access to IPOs: Most companies going through an IPO sell shares to large, institutional investors first, making it hard for individual investors to get in on the action. Most individuals will have to settle for buying shares from other investors on the IPO day.
  • The majority of IPOs underperform the market after three years: Studies suggest that over the longer term, many IPOs underperform the market by a significant amount, making it risky to invest in IPOs. That being said, a company’s financial performance depends on several factors. 

What To Watch Out for After You Invest in IPOs

After you’ve invested in an IPO, you should continue paying attention to your investment. Stock investments are usually long-term things, but that doesn’t mean you can completely ignore your portfolio.

Keep an eye on the price of the shares you purchased and think about how they fit into your overall investment plan. If they gain value, is it a good idea to sell them and deploy that cash elsewhere? If they lose value, should you accept the losses or keep holding them in hopes they’ll rebound? It all depends on your investing and financial goals.

Keep in mind that when you sell investments for a profit you’ll have to pay capital gains taxes. You can pay the lower long-term capital gains rate if you hold shares for at least a year, so it’s often worth it to wait before selling.

Should I Invest in Initial Public Offerings?

Whether you should invest in IPOs depends on your investing goals. IPOs can be a fun way to allocate some of your money and they offer the potential for significant returns. However, they are also risky. 

It may be best to only put a portion of your portfolio into IPOs and let the rest sit in less volatile investments. IPOs are most suitable for people who can handle the volatility inherent in investing in stocks. Those who need more stable investments will be better off investing in other assets.

Frequently Asked Questions (FAQs)

How can beginners invest in initial public offerings?

Beginners can invest in IPOs by working with their brokerage company. All they have to do is submit a buy order for the shares they want to purchase

Do I need a lot of money to invest in initial public offerings?

While having a lot of money will help you get access to shares at the offer price, few investors will have the ability to buy shares directly from companies going public. Typically, only clients of the company underwriting the IPO have the chance to buy shares directly. For individual investors, the best way to get involved is to buy stock from another investor during (or shortly after) the IPO.

What is the best way to invest in initial public offerings?

If you can get access to shares sold directly by the company going public, that is likely the best way to invest in an IPO. Often, the offering price will be the best price available. If that’s not an option for you, consider using a limit order to avoid paying more than you expect due to volatility and work with a broker that doesn’t charge a commission for trades.

The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financialcircumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.

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