If you are well informed, have read the prospectus, have learned about the company and understand the risk, investing in an initial public offering (IPO) could be potentially lucrative. If you are not, it could be a speculative or even inappropriate investment for you.
An IPO is the first time stock has been offered publicly for a previously private company. IPOs are closely watched by the Securities and Exchange Commission, but you should not assume that means they are automatically a good deal. Some will work out well and investors will profit. Others will fail.
Are you willing to put in the work? Your due diligence includes reading the entire prospectus, which is a document the company has registered with the Securities and Exchange Commission. It contains information about the company’s management and financial position as well as, crucially, the terms of the offering.
You should read the whole thing and mark down where you have questions. You may be able to answer some of your own questions, but any significant ones that remain could be crucial.
How do I decide whether the price is right?
It’s important to understand that companies set their own initial stock offering price working with their underwriters. They typically have statements of interest from several large investors, and this informs their pricing decision. Many factors go into the decision about offering price, including market conditions, the company or underwriter’s analysis, negotiation, pricing strategy and even hype.
This offering price may bear little relation to the ultimate market price for the stock. According to the SEC, it is common to see the closing price on the day of the IPO be well above or below the initial offering price.
There is no way to know whether an initial offering price will be high or low. The only thing you can do is perform your due diligence. Consider the stock prices of similar companies. If this IPO is higher, what factors justify that? If the price is lower than that of competitive companies, what weaknesses might explain that?
Being fully aware of the risks is crucial. You should hesitate to invest in an IPO on the advice of an investment advisor alone.
In fact, if you lost money because your investment advisor put your money into an investment that was contrary to your investment strategy, or which was otherwise inappropriate for you, you may have an opportunity to get some of your money back. You may be able to file a claim through the Financial Industry Regulatory Authority (FINRA) arbitration.