When private companies look to raise money, they could do so privately or publicly. Now, companies looking to raise money from the public for the first time would need to conduct an initial public offering (IPO). When companies list their stock for the first time on major exchanges, such as the New York Stock Exchange (NYSE) or Nasdaq, it’s known as an IPO.
Companies that conduct IPOs are often volatile because market participants are trying to find the true value of the stock. Now, if you want to learn to trade IPOs after they’ve stabilized and become established companies in the secondary market, check out how to do that here.
That said, let’s take a look at the IPO process and some nuances of IPOs.
Initial Public Offering (IPO) Explained
Often times, you’ll hear traders say this company is “going public” – that just means it’s an IPO.
Now, companies go through a crucial process to conduct an initial public offering.
First, an external initial open public offering group is created – comprised of underwriters (investment banks or large financial institutions), lawyers, certified public accountants (CPAs). Additionally, the team would consist of the Securities and Exchange Commission (SEC) experts.
Next, information about the business enterprise is compiled, including financial productivity and expected future strategies. This becomes part of the company prospectus, which is sent out for review.
In the next stage of the process, the company’s financial statements are audited, and there is a public opinion about the stock…whether it be good or bad.
Last, the business enterprise files its prospectus and required forms with the SEC and sets the offering date.
Now, there is typically some bias with IPOs.
Not All IPOs Are Hot
Traders and investors are typically distracted by survivorship bias in the IPO market. Market participants often assume that buying shares after an excellent IPO could possibly be profitable. However, that’s not always the case.
Based on experience and analyses have shown that, based on price performance, it’s a 50-50 chance of an IPO being worth less than the offering price within three months.
Now, if you’re looking to invest or trade IPOs, you should learn how to analyze them properly first.
There are a number of reasons why IPOs are volatile over the short term. Companies are generally being supported by investment banks – trying to drum up demand for the stock. That said, it’s often easy to set high expectations…However, the markets tend to figure out the true value of an IPO fairly quickly.
Moreover, once the lockup period expires, employees and early investors are able to sell their shares – which could increase the selling pressure. In turn, this could cause some IPOs to underperform. Keep in mind, the lockup period differs for each IPO, and you could use the SEC’s EDGAR tool to look up lockup dates.
For example, Blue Apron Holdings (APRN) was one IPO that started falling shortly after the offering date. Moreover, once the lockup period expired, the selling pressure continued.
Now, if you’re interested in learning how to trade beaten down – or oversold – small-cap stocks, here are ways to profit in the industry.
Final Thoughts on IPO
When a private company offers shares to the public for the first time, it’s known as an IPO. Remember, the primary goal of an IPO is to raise capital, but there are some other advantages to being a publicly traded company. Now, keep in mind, not all IPOs are hot stocks, and some will even underperform the market. That said, it pays to conduct your due diligence before considering buying recent IPOs.