An initial public offering, or IPO, is when a private company first takes its stock shares public. IPO investing can be risky, as the company’s shares have yet to perform on the open market. On the other hand, investing in an IPO can be extremely rewarding if you can manage to get in on the ground floor of an up-and-coming company. If you qualify for IPO investing, you can typically do so through your brokerage. If you have questions about IPOs or investing in general, perhaps a local financial advisor can help you out.
What Is an IPO?
IPO stands for “initial public offering” and it refers to when a company goes public. In an IPO, a privately held company makes shares in the company available to investors on the stock market. These can be newly issued shares. They can also be shares that were previously held by the founders and early investors.
To invest in an IPO, you have to be among the first to buy shares in the company after it goes public. Some lucky people have bought shares in the IPOs of companies that went on to pay huge dividends or soar in value. But just because investing in IPOs has worked for some in the past doesn’t mean you’ll get the same returns.
It’s harder for the average American to have a run-away success story with an IPO investment than it used to be. In the old days, a regular investor might get a tip-off about something like the Coca-Cola IPO and strike it rich. These days, IPOs are much more scrutinized and publicized. As a result, getting a hot tip that few people know about is less likely to happen for you.
How to Buy IPO Stock
If you want to invest in stocks being offered through an IPO, you’ll need to gain eligibility to do so. In many cases, this means being either a high-net-worth investor or an experienced investor that understands the risks associated with IPOs. Once you’re eligible to invest in an IPO, you’ll need to work with the appropriate brokerage.
Not all brokerages have access to every IPO, so you may need to look around. Even if you find the right brokerage, the amount of investors that can access the IPO might be limited. For example, a brokerage may only offer an IPO opportunity to investors who have a significant amount of assets with the firm or who trade with them often. In other words, you might simply miss the cut.
If you can manage to get into an IPO sale, the purchase process follows the same steps as any other investment. Just pick the number of shares you want to buy and set up your order type and the shares will be yours. Once the trade goes through, the shares will be attributed to your account like any other security.
Some investors may try to sell their IPO shares quickly after they purchase them. While this is technically allowed because the shares are theirs, the practice is generally frowned upon by brokerages. As a result, the brokerage you bought the IPO shares from may bar you from future IPO sales.
Pros and Cons of IPO Investing
Research shows that “beating the market” is not really possible for most people. According to many experts, you’re better off buying and holding a low-cost fund that indexes the market rather than trying to beat the market by trading shares in individual companies.
Moreover, even if you want to pursue active rather than passive investing, IPOs may not be your best bet. Some people argue that we’re currently experiencing an IPO bubble. If this is true, it would mean that company valuations at the time of IPO are inflated. That would mean that those who buy shares at the time of an IPO are less likely to see a return on their investment.
If you follow a value investing philosophy, you’ll look for shares that are inexpensive relative to the true value of the company. But before an IPO, founders try to drum up interest in the IPO and drive up their IPO valuation. As a result, share prices at the time of an IPO can be artificially high. That leaves IPO investors in a vulnerable position. Their shares might lose value soon after the time of the IPO.
If you’re wondering whether you should invest in an IPO, the answer will depend on your general investment philosophy. If you’re content to stick with low-cost investment funds, you’ll probably be fine passing on the IPO hype. However, if you pride yourself on finding the best company stocks to buy, you might be drawn to the potential returns of IPO investing. These days, however, it’s harder to use IPO investing to find under-the-radar deals that will offer reliable long-term returns.
- IPO investing can be a complex venture, so the professional aid of a financial advisor could be helpful. Luckily, finding a financial advisor in your area doesn’t have to be hard. SmartAsset’s free financial advisor matching tool can pair you with up to three local advisors in just five minutes. Get started now.
- Managing the taxes associated with your investment gains is incredibly important. To get an idea of what you might owe, stop by SmartAsset’s capital gains tax calculator.
- Investing in IPOs and other types of stocks can be risky. Therefore, it’s important that you balance your portfolio with safer investments like, ETFs and bonds. Determine your portfolio’s ideal plan with SmartAsset’s asset allocation calculator.
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