Getting the scoop on IPOs
The following guidelines may help you select a winner out of the thousands of companies that have initial public offerings each year:
- Read the prospectus.
Read the preliminary prospectus to find out about the company’s expected growth. The red herring (a preliminary prospectus that provides information but isn’t an offer to sell the security and doesn’t include any offering prices) includes a description of the issuer’s business, the names and addresses of key corporate officers, the ownership amounts of the key officers, any litigation problems, the company’s current capitalization, and how the company plans to use the new funds from the offering.
- Perform fundamental analysis.
Evaluate the company’s financial performance by using fundamental analysis, just like you would for any other stock. Fundamental analysis is a form of security valuation that seeks to determine the intrinsic value of a stock based on the stock’s underlying economics. You then compare the intrinsic value and the asking price. For more details about how to perform a fundamental analysis.
- Check out the company’s management.
Examine the backgrounds of the firm’s senior managers. What is their executive management experience and education? Do they have work experience in their current jobs?
- Read the mission statement.
Investigate the firm’s strategy. Is it realistic? How large is the company’s market? Who is the competition? If the company plans to gain less than 25 percent of the total market, the firm may not be a long-term success.
- Investigate the planned use of funds.
Determine why raising a certain amount of capital is so critical to the company’s success. If the money is used to pay debt, the company might be headed for problems; using the money for expansion is a positive sign.
- Compare IPO prices.
Compare expected IPO prices in the red herring with the final prospectus. If the price is higher in the later prospectus, the underwriters are enthusiastic about the offering. Lower prices indicate a lack of interest by the investment community.
- Determine whether it’s your kind of company.
Decide whether you want to own stock in the company you’re researching. Maybe it’s a great financial opportunity, but you have reservations about the product or service.
- Estimate your planned holding period.
Decide how long you plan to keep the shares. If the IPO is going to be successful, it will be a better long-term investment than short-term investment because IPO stock prices tend to move up or down with the stock market.