Things to Know Before Investing in IPO Stocks

by Riley Raul Reese 2 years ago in stocks

Investing in IPO stocks isn't like other stock market options out there. Check out what experts want you to know before you plunk down your cash for that hot IPO.

Things to Know Before Investing in IPO Stocks

When Facebook revealed its IPO, the world went nuts. People did whatever they could to invest in Facebook just as it hit the stock market. Almost overnight, the phrase "Initial Public Offering" became a codeword for staying on top of the stock market.

To a point, Facebook's IPO set the stage for what the mainstream believes about IPOs. Unfortunately, Facebook's IPO success was not the norm; it was an exception to the rule. In most cases, IPO stocks tend to be seen as very high-risk endeavors.

Investing in IPO stocks isn't really something that should be taken lightly. Many fail. Heck, investors even say that most people shouldn't even consider buying IPO stocks until they know the following facts, tips, and tricks involving these risky investments.

FIrst, let's talk about what an IPO stock is.

There's no point in investing in IPO stocks if you don't know what an IPO is. An IPO is an Initial Public Offering. This is the stock that companies offer when they first make the switch from privately owned to a publicly-traded company.

You don't just go public without reason—and that's something people need to be aware of. Companies go public because they want to raise funds, get an acquisition underway, allow venture capitalists to exist their stakes, or otherwise change the way that they make a profit.

This means that the company will probably change quite a bit within a year or so after the IPO is released. This means that there is risk involved, and you may not recognize the company you initially bought stock in.

As risky as investing in IPO stocks can be, it's still not the riskiest thing you can do.

Make no mistake about it—stocks are risky, and you can lose everything you spent buying them in an instant. However, there is some good news about an IPO.

In order for a company to go public, it has to undergo a serious amount of scrutiny from major banks and the Securities Exchange Commission. They also have to follow certain regulations in order to ensure that their stockholders are treated well.

Generally speaking, IPOs are highly esteemed if they are on a major stock exchange. It takes a lot to get onto a stock exchange in the first place, and the prestige is something that shouldn't be shrugged off.

That being said, standards have relaxed a bit and you should still be aware of risks.

Before you start investing in IPO stocks, make sure it's being underwritten and brokered by an esteemed bank.

In the stock market world, there is still some risk of having sham companies create stocks. Some OTC Pink penny stocks, for example, have been caught being sham companies that were developed by people looking to make a quick buck off witless investors.

In order for an IPO stock to be traded on a major exchange, they will need to have a bank underwrite their stock. This is crucial to look into, especially if you are unsure of whether you want to invest in them.

Top-rated banks are very intense about which IPOs they will want to underwrite, and even more protective when it comes to white IPOs they will broker. This, in turn, prevents a loss for them and for their clients.

So, you might want to check to see which bank is working with the IPO stock shares you want to buy. Reliable banks for quality stocks include Goldman Sachs, JP Morgan, Merrill Lynch, Barclays, Bank of America, Credit Suisse, and Morgan Stanley.

In order to start investing in IPO stocks, you will have to have an account with a brokerage that offers the IPO you want to buy.

Not all brokerages will be privy to all IPO stocks, primarily because these stocks are literally the first step to going public. If you want to get an IPO stock, make sure to check that you're with a brokerage that will allow you to invest in the IPO you want.

Before you consider signing up with a new broker to get into an IPO, you might need to take a step back. Some brokers will not allow your first transactions to be IPO-related, and others may require a minimum deposit that might be above your budget.

In other words, do your homework.

Read the prospectus, and remember that research is key.

You already know that an IPO is typically done for major fundraising efforts, or to kick off sweeping changes that will supercharge the company's value. The fact is that you need to find out what is making the company get into stocks.

Considering how much money investing in IPO stocks can raise, don't you think you should figure out where that money is going? The prospectus of any IPO should tell you what that money is used for, the risks the company has, and what the company wants to do. This, in turn, can help you figure out whether it's actually a good choice.

You may want to wait until the lock-up period is over.

When investing in IPO stocks, you will hear the term "lock-up." This is a period of time in which the company's insiders are prohibited from selling any shares of stock. During the lock-up period, prices are often much higher or lower than they should be. This time period is often around three months to two years long.

Since price volatility is an issue, you might want to wait until you see what insiders choose to do with their stock before you make a move. You might find that a lot of insiders are selling shares—which could signal trouble others aren't seeing.

Don't buy the hype.

Everyone's currently trying their hand at investing in IPO stocks, just because they are trendy. It seems like every publication out there is talking about how this or that company is going to be the next "unicorn company" that'll offer massive returns.

Hype is bad. Hype is one of the reasons why some of the worst stock market crashes in history have happened. If you drink the Kool-Aid without actually looking at the facts, you will end up losing a lot of money in IPOs.

Not every offering is going to be a Facebook IPO. In fact, most flop over the long run. If you aren't sure about a stock, it's better to just wait and see what happens to its price.

Be wary of financial advisors and brokers that encourage you to invest in a specific IPO stock.

Investopedia notes that one of the red flags individual investors should watch out for is when brokerages try to persuade them to buy a specific IPO. Simply put, there may be an ulterior motive in them deciding to sell you that stock.

As Investopediaexplained:

"This is a clear indication that most institutions and money managers have graciously passed on the underwriter's attempts to sell them stock. In this situation, individual investors are likely getting the bottom feed, the leftovers that the "big money" didn't want. If your broker is strongly pitching shares, there is probably a reason behind the high number of these available stocks."
You don't want to end up with scraps. Find out what's really going on with that stock, instead.

Don't expect to find objective research when investing in IPO stocks.

Objectivity isn't something IPO stock writeups are known for, especially if they are written by media outlets that are typically linked to PR agencies. Finding real, objective research on any IPO will be hard, primarily because it's not easy to get your hands on a private company's data.

This is one of the reasons why IPOS are some of the most dangerous investments out there. It's really very difficult to figure out what you're getting into.

If you're a beginner, an IPO is a bad move.

If you're just learning the steps to invest in the stock market, investing in IPO stocks is not a good move. IPOs require a lot more research, a lot more knowledge, and a lot more money than many beginner stock investments do. Moreover, they are extremely risky compared to something more stable.

If you are just learning the ropes, it's totally okay to sit the IPO craze out. In fact, it's one of the wisest things you can do. If you're new to investing, take your time to learn a bit and find out about low-risk investment options that can give you a tour of investing's fundamentals. You'll thank yourself later.

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Riley Raul Reese

Riley Reese is comic book fanatic who loves anything that has to do with science-fiction, anime, action movies, and Monster Energy drink.

See all posts by Riley Raul Reese