Are IPOs worth buying?

Are IPOs worth buying?

NAV TL;DR

If you don’t have time to read through the whole article, you can check out our short version below.

  • Many people choose to put their money in IPOs as it allows them to invest in firms with high growth potential at an early stage
  • However, some IPOs may not live up to all the hype and expectations, leading to disappointment and losses.
  • Do a thorough research on the company’s fundamentals (most key information can be found in IPO prospectus) to decide if the firm is worth its valuation.

An Initial Public Offering (IPO) refers to a private firm listing its shares on a stock exchange, making them available to the public. This provides retail investors with an opportunity to subscribe for shares of a company prior to its commencement of trading on a stock exchange such as the Singapore Exchange (SGX).

As a buyer of a newly listed company, you will be amongst the earliest investors to have the opportunity to own shares of the firm. Many people choose to put their money in IPOs as it allows investors to invest in firms with high growth potential at an early stage. This may provide investors with the chance to earn huge profits rapidly in a short span of time while building their wealth in the long term.

On the flipside, there is also much risk involved. Some IPOs may not live up to all the hype and expectations, leading to disappointment and losses. As such, IPOs are not always ideal investments. Here are some reasons why IPOs may not be worth buying:

  • Lack of information on past performances

Many firms that go public have not been in the market for a substantial period of time. Thus, IPOs can be risky for investors as there is little or no previous market activity and historical data of their previous performances that you can use to evaluate the firm’s value. Without information on a company’s past performance, it is extremely challenging to predict how well it will perform in the future and whether it will be a good investment opportunity.

  • Difficult to price

Since there is no market price prior to the offering and most firms going public have little or no operating history, it is difficult to obtain a reasonable gauge of the price of the firm’s share. For instance, on 17 May 2012, Facebook launched its IPO at a price of US$38. If you had purchased US$10,000 worth of Facebook shares at its IPO, the shares would be valued at US$83,016 on 17 May 2021. That would mean that you gained a compound annual growth rate of 26.5%.

However, on 4 September 2012, Facebook shares actually plunged and hit a historic low of US$17.73. If you had waited slightly longer, your $10,000 worth of shares would have been worth US$177,924 on 17 May 2021. That would mean a significant compound annual growth rate of 37.69%.

Therefore, it would be more advisable if you remain patient and observe the company’s performance in the market for a certain period. This will allow you to make a much more informed choice on whether you should invest in the firm’s shares, among other considerations.

  • Steep price declines after lock-up period ends

During a company’s lock-up period, company insiders are not allowed to sell their shares for a fixed time immediately after the IPO, typically 180 days. However, as soon as the lock-up period expires, these insiders can cash out on their shares and profit from the sale if the stocks underwent a significant price increase over the period. Thus, if you are still interested in buying the stocks after researching on the firm during the lock-up period, you may be able to purchase these shares at a better price after the 6-month period ends.

That being said, some investors may still opt to invest in an IPO. In that case, you will need to do a thorough research on the company’s fundamentals to decide if the firm is worth its valuation. What is good to know is that most of this key information can be found in the IPO prospectus, which contains all the required details pertaining to the offering.

Avoid investment scams

8 Things to Look Out for When Reading IPO Prospectus

1. Summary

The summary section covers the main details that most concern the investor, including the overview, competitive strengths, strategies, and future plans of the company. You need to be aware of what the business is about, how it makes money and how the industry prospects are like before you consider whether to invest in the company.

2. Financial Statements

The financial data that is included in the prospectus gives you an overall view of the financial health of the firm. By looking at the financial statements of the company, you will be able to figure out if the company is taking on too much debt and if it has been making consistent revenue and profit.

Financial information of the company is vital to determining if the business is sustainable, has a positive long-term outlook and if it has good fundamentals.

3. Industry Prospect

Learning about the industry that the company is in is important as the performance of an industry has great influence on how well a firm does. An industry that is rapidly growing and has an optimistic prospect will be a better investment choice.

You will also be able to find a description of financial measures that are key to the industry and overview of how the firm that is going public fares in comparison with the industry.

4. Use of Proceeds

The goal of an IPO is to raise fund from the public for the company, hence the prospectus will outline how the funds will be used.
It is essential for you to find out how the company intends to use the capital raised. Questions you should ask include – is the company planning to use the funds raised to pay off its debts? Or it could be utilising these funds to support its expansion.

Generally, firms that plan to put their funds back into the business to fund growth are more likely to have a better long-term outlook and will serve as a more stable investment opportunity.

Avoid investment scams

5. Management Details

The management team oversees daily operations of the company and is involved with key business decisions. Hence, it is important to dedicate some time to read and understand the management reporting structure, as well as the roles and experiences of key management personnel. Questions to keep in mind include – how long have they been with the firm? What are their salary packages like?

If you find several negative articles or forums about the management team, that should raise an eyebrow and prompt you to research further before deciding on whether to invest. On the other hand, if you find that key management leaders have a stake in the company that is prepared to go for an IPO, that will usually mean that their interests are more aligned with that of the shareholders.

Below are investment scam examples designed for the “Beware! Investment Scams” campaign in 2017, conducted by the national financial education programme MoneySense and the Securities Investors Association Singapore (SIAS). These examples include the various red flags that are highlighted above.

6. Risk Factors

Finally, understanding the risks factors associated with the IPO is extremely important. The part of the prospectus on risk factors identifies different risks that the firm may face, depending on market or political/economic conditions.

You should carefully consider the risks associated with the business before investing in any IPO and decide if you can stomach the risks.

7. Shares on Offer & Offer Price

The IPO prospectus includes details about the number of securities that are being offered and the price of the security.

Additionally, most IPOs includes both a public tranche and a placement tranche. The placement tranche is only offered to a particular group of investors such as institutional investors, banks, insurance companies or high net worth individuals while the public tranche is offered to retail investors.

Just so you know, some IPOs do not offer a public tranche. Companies can choose to remain as a privately-owned firm by issuing a private placement only. Doing so allows them to sell a more complex security since their targeted investors are accredited who understand the potential risks and rewards involved.

8. Indicative Timeline

The prospectus will contain an indicative timetable of when investors must apply for the IPO by and when the stock will start trading on the stock market. Hence, do look out for important dates leading up to the date of listing.

You can also find the trading commencement date of an IPO company through your brokers. Alternatively, the information can be found via sgx.com.

How to apply for an IPO

If you believe that the company has good fundamentals and have an optimistic outlook after looking through the IPO prospectus, and you are still interested in investing in the firm’s IPO, here are some things to take note:

In order to apply for an IPO, you will first need to open a CDP account to store the shares that you will be credited to you if your IPO application is successful. If you are interested to open a CDP account, find out more through our step-by-step guide.

Do be aware that it takes up to 2 days to open a CDP account so be sure to factor this in your plan to apply for an IPO.

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Disclaimers and Important Notice
This article is meant for information only and should not be relied upon as financial advice. Before making any decision to buy, sell or hold any investment or insurance product, you should seek advice from a financial adviser regarding its suitability.

All investments come with risks and you can lose money on your investment. Invest only if you understand and can monitor your investment. Diversify your investments and avoid investing a large portion of your money in a single product issuer.

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