Investing in IPOs - How does it work?

How does an IPO work?

An initial public offering (IPO), also known as a float, is the first time the stock of a private company is available to the public. IPOs are an opportunity for investors to own shares in a growing business, and after the IPO investors will be able to sell or buy more shares on the stock market.

When a company decides to go public, it first has to determine its financial goals, how much it will need to raise at the IPO, what securities it will offer and its initial listing price. When those factors have been determined, the company can then lodge a prospectus with the Australian Securities and Investment Commission (ASIC). The prospectus contains important information investors need to know about the company and the offer. Once approved by ASIC, the company can then make their initial public offering.

How can you invest an IPO?

Investing in IPOs can be challenging for some investors. To ensure that the entire first offering will be sold, companies tend to set their sights on institutional investors, therefore making IPOs tricky to access for retail investors.

For retail investors looking to invest in IPOs, they will typically have to engage with a stock broker and have a broking account. Whether you will gain access to a particular IPO also depends on the brokeage house you are using. Some brokerage houses receive more allocations than others. Investors could also be limited by the number of shares they can purchase or in some cases there is a minimum number of shares required to be purchased.  It is also worth noting that brokers tend to be selective about who they notify about each IPO.

If you’re able to invest in an IPO, another challenge you may face is the risk of an IPO being oversubscribed, so to avoid missing out you should contact your broker as soon as possible.

Investors who are not able to access IPOs can still take advantage of investing in growing businesses. While you may not be able to invest at the IPO stage you can still invest in a stock when it first lists on an exchange.  Therefore, it could be worthwhile keeping abreast of upcoming IPOs.

Should you invest in an IPO?

In the past, getting in at the early stages of a business has sometimes led to success for investors. Take Amazon as a classic example. When the online retailer made its initial public offering (IPO) in 1997 its share price was US$18, at the time of writing Amazon’s share price hovers around US$1,800! The Amazon investors who got in at the IPO stage or directly after, and held on to their shares are likely very chuffed with the result. 

However, an outcome such as Amazon’s isn’t all that common and while a share price can rise after an IPO, it can also fall. A good example of this was the dot.com bubble that started in the late 1990s when many new technology companies were listing on the stock market for the first time. Some investors got so excited about the potential of the internet they began investing in any and all tech companies, often disregarding whether or not a company would be profitable. When the bubble eventually popped it resulted in 130 internet companies folding and many unhappy investors.

Related article: 4 Stock Market Crashes and What Caused Them 

Here’s what you should consider 

Before investing in an IPO, you should read the prospectus carefully. To understand if a business is reasonably priced and could be a sound investment, consider the following:

• the long-term growth prospects
• the anticipated balance sheets’ strength after the float
• what the company expects to earn
• the broader sector e.g. technology, mining etc.

In the end, deciding if investing in an IPO or in a growing company is right for you will likely come down to your investment strategy (and your strategy should take into account your personal circumstances, risk tolerance and investment goals).  If tried and tested companies are your focus, investing in IPOs may throw you off course. However, if you’re looking for stocks with growth potential IPOs are an option, although a risky one at that.

IPOs launching on the ASX

Here are a few companies looking to make their Australian stock market debut in the coming months:

Source: ASX

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International IPOs launching in 2019

In addition to Uber, there are a number of other prominent companies set to make their initial public offering in 2019, including:

• Pinterest
• Slack
• Airbnb
• Bumble
• Robin Hood

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Header image: MaximP (Shutterstock)