Investing in IPOs (Initial Public Offerings) in 2024: Here’s what investors need to know

Nick Sundich Nick Sundich, February 27, 2024

Investing in IPOs offers the opportunity for investors to make gains they couldn’t make with any other company, but also offer a risk of making significant losses which you may not be able to recoup. They’re also a major milestone for companies involved, as they not only provide access to significant amounts of capital but also increase the company’s visibility and credibility in the market. This public offering also allows the company to establish a market value for its shares, which can be used as a benchmark for future valuations.

In this guide, we look at what IPOs are, why they are a big deal, as well as the advantages and disadvantages of investing in them. Investors looking for a general answer to the question ‘should I buy an IPO’ should expect to be disappointed, because we do not answer the question in relation to upcoming stocks, nor whether you should just buy any without consideration of the company. Some can be great opportunities, but not so much in respect of others.

 

What is an IPO?

An Initial Public Offering (IPO) is a pivotal moment for a private corporation, signifying the first time it offers its shares of stock for sale to the public. This process transforms a company from private to public, thereby providing an opportunity for the company to raise capital from public investors to fund expansion and new projects, while also potentially allowing early investors and insiders to realize gains from their investment.

Once a company successfully completes its IPO, it becomes listed on a stock exchange like the ASX or NYSE, allowing its shares to be traded publicly. This opens up the possibility for liquidity for early investors and allows the company to continuously raise capital through secondary offerings.

 

How can I buy an IPO?

As with any stock, from a broker. But what about before it even goes public? Yes, from a broker. You see, stocks hire a broker to help with their listing and you’re an institutional investor and/or client of that broker, you may get access. Alternatively, you may be able to buy shares from certain platforms the company might list on. But most likely, you’ll have to try your luck when the stock comes on market.

 

Why is an IPO such a big deal for companies?

Most prominently, because it grants the company a significant profile that it may not otherwise have. In many cases (but not all), they also provide funding to the company that can help propel its growth to the next level.

The road to an IPO is not an easy one, as companies must go through a rigorous and lengthy process before they can finally go public. This includes undergoing thorough financial and legal due diligence, creating a prospectus that outlines the company’s business model, financials, risks and potential growth opportunities, as well as conducting roadshows to generate interest from potential investors. Yet the process of doing so can improve the company’s governance and may even attract new employees, management and directors.

However, IPOs also come with their own set of challenges and risks. The process can be expensive and time-consuming, requiring significant resources and expertise. In addition, companies that go public may face increased scrutiny from shareholders and potential legal issues if they fail to meet expectations or disclose accurate information.

 

Advantages of investing in IPOs

Investing in Initial Public Offerings (IPOs) presents several advantages. One is the potential for significant short-term gains. This is because IPOs are often priced lower than the actual value of the company, which can lead to a quick increase in stock price once it begins trading on the open market. This presents an opportunity for investors to make a profit in a relatively short period of time.

Another advantage is the chance to get in on the ground floor of potentially the next big company in an industry. IPOs are typically for companies that are just starting to go public, which means they have a lot of room for growth and potential success. By investing in these companies early on, investors can potentially reap significant rewards as the company grows and becomes more established.

 

Diversification of your portfolio

In addition to the potential for short-term gains and getting in on the ground floor, participating in an IPO also allows for diversification of an investment portfolio. By incorporating IPOs into a portfolio, investors can balance out risk by having a mix of securities from different industries and stages of growth.

Furthermore, investing in an IPO allows individuals to support and grow with a company from its early stages. This can be a rewarding experience, especially if the company becomes successful and generates profits. It also provides individuals with a unique opportunity to learn more about the company and its operations, as well as potentially participate in shareholder meetings and have a voice in the company’s decisions.

 

Disadvantages of investing in IPOs

Although investing in Initial Public Offerings (IPOs) can be an exciting venture, it carries inherent risks. Liquidity is often limited shortly after the offering, making it difficult to sell shares at a reasonable price. Additionally, IPOs can be susceptible to hype, driving valuations to unsustainable levels, which may lead to poor long-term performance. There’s also a lack of historical data to analyse, making it a challenge to make informed investment decisions. Moreover, the phenomenon of underperformance known as ‘flipping’ can occur if the stock price drops shortly after the IPO, which can cause substantial losses for investors who bought in at the offering price. You just can never be sure how the issue price is determined.

 

 

Finally, investors should be aware of any lock-up/escrow periods that may restrict them from selling their shares immediately after the IPO. When restrictions are lifted, those shareholders may cash out, and this can impact the share price. It goes without saying that it is essential to keep an eye on the company’s performance after going public, as it may not meet expectations or face challenges in sustaining its initial success.

Deciding whether to invest in an IPO requires careful consideration. Investors should thoroughly research the company’s financials, management team, industry trends, and competition before making any investment decisions. It’s also essential to have a diversified portfolio and not put all of one’s assets into one IPO as it can be a high-risk and volatile investment.

 

Conclusion

In conclusion, investing in IPOs can be a high-risk, high-reward venture, in many ways similar to already listed stocks, but with their own set of challenges. If considering buying, you must carefully assess the risks and potential benefits before making any investment decisions. Additionally, it’s essential to continually monitor the company’s performance and be prepared for potential fluctuations in the stock price.

With proper research and a well-diversified portfolio, investing in IPOs can potentially yield significant returns for investors. Above all else, keep in mind that (given some can turn out to be duds) it’s not just about the initial excitement but also the long-term potential of the company.

 

What are the Best ASX Stocks to invest in right now?

Check our buy/sell tips

 

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