How to Research and Select IPOs to Invest in

How to Research and Select IPOs to Invest in blog post image

An Initial Public Offering (IPO) is when a private company first offers shares of stock for sale to the public. Investing in IPOs can be risky but also lucrative if you pick the right ones. Here is a step-by-step guide on how to research and select promising IPOs to invest in.

Understand What an IPO Is?

 

When a private company wants to raise capital and open up ownership, it can hold an IPO and issue shares of stock for purchase by investors.

Some key things to know about IPOs

  • The company offers shares via an investment bank that facilitates pricing and selling the newly issued stock.
  • Shares are offered at a set initial price, often determined by demand and projected value.
  • Once public trading begins, the stock price can rise rapidly if demand is high.
  • Insiders may be restricted from selling their shares for a “lock-up period” after the IPO.
  • The company gets an infusion of capital to fund growth plans. Investors get an opportunity to buy shares and potentially profit.

 

Weigh the Pros and Cons of IPO Investing

IPOs come with major risks and rewards for investors. Consider these key pros and cons when deciding if investing in IPOs is right for you:

Pros

  • Potential for high returns – Newly issued stocks can surge in the first days and weeks of trading if demand is strong, allowing for big profits.
  • Get in early – Buying shares at the IPO price allows you to get in when the stock is on the ground floor before potential growth.
  • New companies – IPOs allow you to invest in new and emerging companies with innovative products/services before they become household names.

Cons

  • Unproven companies – You are investing in startups and younger companies that are often unprofitable and still finding their footing.
  • Overvaluation risk – IPO prices are set based on demand and growth projections, but the business model may fail leading to losses.
  • Volatility – Stock prices after IPOs can swing wildly based on hype, demand, and other factors.
  • Limited financial data – With a short operating history, it can be hard to value IPO companies based on financial metrics.

 

Perform Market Research on the IPO Company

 

Once you decide if IPO investing fits your risk tolerance, thoroughly research companies going public:

Founders and Management Team

 

  • Look for a strong, experienced leadership team with proven success in the industry. This increases the odds they can guide the business well after the IPO.

Business Model and Competitive Advantage

 

  • Understand the company’s business model, products/services, and what gives them a competitive edge. Identify their addressable market and growth opportunities.

 

Financial Performance and Projections

 

  • Dig into their financials leading up to the IPO to assess revenue growth, profitability, debt levels, and cash flow. Review management projections for the next 3-5 years.

 

Use of IPO Proceeds

 

  • Learn how the company plans to use the capital raised from the IPO. Growth plans and capital needs determine how diluted existing shareholders will become.

Lock-up Agreements

 

  • Insiders often sign agreements restricting them from selling shares for 180 days or longer after the IPO. This aligns their interests with new investors.

Value the IPO Price

 

The initial share price set by the underwriter may or may not reflect fair value for the company. Do your own careful valuation:

Peer Valuation Analysis

 

  • Compare key valuation metrics like P/E ratios and Price/Sales ratios to similar publicly traded companies. Does the IPO price properly reflect value?

Discounted Cash Flow Model

 

  • Project future free cash flows, discount them back to today at the company’s weighted average cost of capital, and assess upside or downside versus the IPO price.

Market Hype

 

  • Consider if high recent returns in the sector or extreme market optimism is inflating the price beyond reasonability. Don’t invest in overhyped IPOs.

Historical IPO Performance

 

  • Research how similarly sized IPOs in the sector performed in the 3-12 months after going public. This can benchmark expectations.

Time Your Purchase After Trading Begins

It’s hard to buy shares at the actual IPO price as an individual investor. But you can buy after public trading begins:

Don’t Chase

 

  • Avoid FOMO and wait for the initial euphoria to settle before making your first purchase. Consider dollar cost averaging over the first few weeks/months.

Follow the Lock-up Expiration Dates

 

  • Insider selling after lock-ups expire can pressure the stock price, so wait to buy until after this wave of selling passes.

Limit Orders Over Market Orders

 

  • Use limit orders when first buying shares to control the entry price rather than buying at inflated market prices.

Watch for Option Expirations

 

  • High trading activity around standard monthly option expirations can impact prices, so tread carefully during expiration weeks.

Keep Emotion out of It

 

  • Don’t let hype or fear of missing out drive your decision. Stick to the valuation plan and timeline you defined upfront.

Build a Diversified IPO Portfolio

 

Since individual IPOs carry risks, make IPO investing a small portion of your broader portfolio:

  • Cap IPO exposure – Limit IPOs to 5-10% of your total portfolio value at most.
  • Invest in multiple IPOs – Build a basket of at least 3-5 IPOs across different sectors to reduce risk.
  • Hold non-IPO stocks – Have established, profitable companies as the core holdings for stability.
  • Rebalance periodically – If an IPO surges and becomes too large a share of your portfolio, take some profits and rebalance.
  • Avoid overexposure – Don’t load up further on IPO stocks after your initial purchases since they now carry more downside risk.

Thorough research, valuation analysis, timing, diversification, and avoiding emotion can lead to successful IPO investing. Follow these steps to prudently select and manage IPO opportunities while mitigating the inherent risks.

Alternative Investment Specialist

 

New capital link has helped countless investors maximise there portfolios while minimising their risk. If your interested in any financial vehicle then our experienced team can help. Contact su today for a free no obligation consultation.

by Rachel Buscall

by Rachel Buscall

Co-Founder & Managing Director at New Capital Link. Having started her career in the financial sector, Rachel demonstrated a natural flair for entrepreneurship.

New Capital Link

Alternative investment specialists offering structured opportunities across the UK & Overseas.

New Capital Link is a boutique London-based introducer that offers unique UK & global investment opportunities worldwide.

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What are the key risks?

1. You could lose all the money you invest

If the business offering this investment fails, there is a high risk that you will lose all your money. Businesses like this often fail as they usually use risky investment strategies. 

Advertised rates of return aren’t guaranteed. This is not a savings account. If the issuer doesn’t pay you back as agreed, you could earn less money than expected or nothing at all. A higher advertised rate of return means a higher risk of losing your money. If it looks too good to be true, it probably is.

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2. You are unlikely to be protected if something goes wrong

The business offering this investment is not regulated by the FCA. Protection from the Financial Services Compensation Scheme (FSCS) only considers claims against failed regulated firms. Learn more about FSCS protection here. https://www.fscs.org.uk/what-we-cover/investments/ or

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The Financial Ombudsman Service (FOS) will not be able to consider complaints related to this firm or Protection from the Financial Ombudsman Service (FOS) does not cover poor investment performance. If you have a complaint against an FCA-regulated firm, FOS may be able to consider it. Learn more about FOS protection here. https://www.financial-ombudsman.org.uk/consumers

3. You are unlikely to get your money back quickly

This type of business could face cash-flow problems that delay interest payments. It could also fail altogether and be unable to repay investors their money. 

You are unlikely to be able to cash in your investment early by selling it. You are usually locked in until the business has paid you back over the period agreed. In the rare circumstances where it is possible to sell your investment in a ‘secondary market’, you may not find a buyer at the price you are willing to sell.

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This investment has a complex structure based on other risky investments. A business that raises money like this lends it to, or invests it in, other businesses or property. This makes it difficult for the investor to know where their money is going.

This makes it difficult to predict how risky the investment is, but it will most likely be high.

You may wish to get financial advice before deciding to invest.

5. Don’t put all your eggs in one basket

Putting all your money into a single business or type of investment for example, is risky. Spreading your money across different investments makes you less dependent on any one to do well. 

A good rule of thumb is not to invest more than 10% of your money in high-risk investments. https://www.fca.org.uk/investsmart/5-questions-ask-you-invest

If you are interested in learning more about how to protect yourself, visit the FCA’s website here: https://www.fca.org.uk/investsmart

For further information about minibonds, visit the FCA’s website here.https://www.fca.org.uk/consumers/mini-bonds