A lot of people hold IPOs in high esteem – treating the more high profile Initial Public Offerings as though they are some sort of lottery. But are IPOs really all that desirable? Some experts feel that running after IPOs is a bad idea. For a cautious investor, it may be a good idea to get both sides of the argument:
The initial public offering is a way for a company to raise new capital. This could be a part of the process of expansion of the company or its operations. It could also be offered when transforming a privately held company into a company whose shares are freely traded on the market. An IPO could offer retail investors or individuals as well as institutional investors the chance to invest in a company they see as sound or profitable. The understanding is that applying for and being allotted shares can be a great investment that will earn either by way of reselling or by way of dividend and increased valuation.
Investing in an IPO gives the investor an opportunity to become associated with a good company from the early stages and enjoy long-term benefits from that association. Investing in an IPO can be like a lottery in the sense that a small investment can quickly become much more valuable, fetching a tidy profit fairly quickly.
There may be instances where an IPO is more hype than substance. While the company may have been able to create a positive story around its IPO, this may not be backed by the fundamentals of the company. Even companies with limited track records may be able to generate a positive buzz around their IPO, and if investors do not perform their due diligence, they could be in for a rude shock.
One of the real problems with an IPO is that there is no guarantee of share prices climbing after the initial offering. While we've heard of share prices rising significantly on the first day of trading and offering a handsome profit in the short term, the opposite may also be true. Investors may well find that prices actually fall after the completion of the IPO and that they are unable to even recover their initial investment subsequently.
In some cases, an IPO could be something of a gamble, particularly if the investor is chasing a sector rather examining the fundamentals of the company itself. So for instance, if tech stocks or energy stocks or the chemical sector is generally doing well, any IPO in that sector is seen as a viable investment. However, the track record of the particular company may not reflect this.
There are other issues as well: applying for an IPO can be time-consuming and tedious, requiring the filling of forms and applications. There is a transaction cost as well, such as 5 to 7% charged by underwriters in an IPO. Further, there are issues of privacy when applying for an IPO because the initial application requires the investor to divulge significant amounts of persona information. The bottom line is that IPOs have several pros and cons. It is up to the investor to do their due diligence in respect of the company and the sector before applying.
Do you have something interesting you would like to share? Write to us at [email protected]
