A Guide to IPO Investing
Investing in initial public offerings (IPOs) has been and continues to be largely reserved for institutional investors. To clarify, we’re referring to the right to buy shares in a company prior to the shares trading on the open market.
Occasionally, individual investors can get in on the IPO action, maybe to the tune of a hundred shares, if they’re lucky. While 100 shares is probably chump change to institutional investors, it could prove to be a sizable holding for an individual.
However, given the difficulty for individual investors in acquiring pre-IPO shares, we choose to focus this month’s education piece on recent IPOs, or companies that recently had an IPO and whose shares currently trade on the open market. It should be noted that even institutional investors often don’t get all of the shares they want on the offering, and make subsequent purchases in the aftermarket.
Investing in recent IPOs is much like investing in seasoned stocks, with the noted exception of the limited availability of information. If a firm is a recent IPO, a good place to start your research is the prospectus, also know as the S-1 filing. The SEC does a great job of posting S-1 and S-1/A (amendment) filings on its EDGAR site (Example: Salary.com's S-1/A filing).
The prospectus generally provides information related to the offering details, the company’s business, its markets, its products, its strategies, risks associated with the company, and the all important financial information.
So, how do you evaluate a newly-public company? Here are factors that need to be considered:
Do you understand what the company does?
Is its industry in a growth mode?
Does it have a competitive advantage?
How does a company compare to its peers on its most basic financial criteria?
- Price-earnings ratio
- Price/sales
- Debt/equity
- Operating cash flow growth (make sure cash flow is positive)
- Historical sales growth
- Historical earnings growth
The biggest obstacle you will find is lack of data. Even if you buy after the initial public offering has settled in, IPO's are still speculative, with little or no public trading history. So, make sure IPO's are relegated to a very small portion of your portfolio.
As always, we recommend that you perform the needed due diligence prior to acquiring a position. We will leave you with one final tidbit – recent IPOs with positive GAAP earnings tend to be the ones that turn into winners.
(click a star)
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