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Tips for Investing in Initial Public Offering (IPOs)

21 Mar

Most people think Stocks investments is just eating a piece of cake. You do not have to be there physically to control your investments, you just browse daily or weekly on Dar es Salaam Stock Exchange site and manage your portfolio and your money multiplies.

Sounds so much Easier. In the days of dotcom mania, investors could throw money into an IPO and be almost guaranteed killer returns. Numerous companies, experienced huge first-day gains, but ended up  disappointing investors in the long-term. People who had the foresight to get  in, and out, on some of these companies, made investing look way too easy.

However, no investment is a sure thing. Investors could no  longer expect the double and triple-digit gains they got in the early tech IPO  days simply by flipping stocks. There is  still money to be made in IPOs, but the focus has shifted from the quick buck to  the long-term outlook. Rather than trying to capitalize on a stock’s initial  bounce, investors are more inclined to carefully scrutinize long-term prospects.
IPOs can be a risky investment. For the individual investor, it is tough to  predict what the stock will do on its initial day of trading and in the near  future because there is often little historical data with which to  analyze the company. Also, most IPOs are of companies going through a  transitory growth period, which are subject to additional uncertainty regarding  their future values.

WHAT IS AN IPO?

  ‘An IPO is The first sale of stock by a private company to the public. IPOs are  often issued by smaller, younger companies seeking the capital to  expand, but can also be done by large privately owned companies looking to  become publicly traded.’

 Even if you have a longer-term focus, finding a good IPO is difficult. IPOs have  many unique risks that make them different from the average stock which has been  trading for a while. If you do decide to take a chance on an IPO, here are five  points to keep in mind: 

1. Objective research is a scarce commodity 

Getting  information on companies set to go public is tough. Unlike most publicly traded  companies, private companies do not have swarms of  analysts covering them, attempting to uncover possible cracks in their corporate armor.  Remember that although most companies try to fully disclose all information in  their prospectus it is still written by  them and not by an unbiased third-party.

Search the Internet for  information on the company and its competitors, financing, past press releases,  as well as overall industry health. Even though info may be scarce, learning as  much as you can about the company is a crucial step in making a wise investment.  On the other hand, your research may lead to the discovery that a company’s  prospects are being overblown and that not acting on the investment opportunity  is the best idea.

2. Pick a company with strong brokers

Try to select a  company that has a strong underwriter.  I am not saying that the big investment banks never bring duds public, but in  general, quality brokerages bring quality companies public. Exercise more  caution when selecting smaller brokerages, because they may be willing to  underwrite any company.  However, one positive of smaller brokers is that, because of their smaller  client base, they make it easier for the individual investor to purchase pre-IPO  shares. Be aware  that most large brokerage firms will not allow your first investment to be an  IPO. The only individual investors who get in on IPOs are long-standing,  established (and often high-net-worth) customers. Of course in our country most of the brokerage firms aims at SELLING instead of ADVISING an investor.

3. Always read the prospectus

I have told you not to put all  your faith in it, but you should never skip reading the prospectus. It may be a  dry read, but the prospectus lays out the company’s risks and opportunities,  along with the proposed uses for the money raised by the IPO.

For example, if  the money is going to repay loans, or buy the equity from founders or private  investors, then look out! It is a bad sign if the company cannot afford to repay  its loans without issuing stock. Money that is going towards research, marketing  or expanding into new markets paints a better picture. Most companies have  learned that over-promising and under-delivering are mistakes often made by  those vying for marketplace success. Therefore, one of the biggest things to be  on the lookout for while reading a prospectus is an overly optimistic future  earnings outlook; this means reading the projected accounting figures carefully.
You can always request the prospectus from the broker bringing the  company public.  Get a professional to help you understand the prospectus because not anyone can read and understand the accounting information and statements disclosed in a prospectus.

4. Be cautious

Skepticism is a positive attribute to  cultivate in the IPO market. As i mentioned earlier, there is always a lot of  uncertainty surrounding IPOs, mainly because of the lack of available  information. Therefore, you should always approach an IPO with caution.
If your broker recommends an IPO, you should exercise increased caution.  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. This brings up an important point: even if you find a company going  public that you deem to be a worthwhile investment, it’s possible you won’t be  able to get shares. Brokers have a habit of saving their IPO allocations for  favored clients, so unless you are a high roller, chances are good that you  won’t be able to get in.

5. Consider waiting for the lock-up period to end

The lock-up period is a legally binding contract (Mostly 3 to 24 months)  between the underwriters and insiders of the company prohibiting them from  selling any shares of stock for a specified period.
The point here is that waiting until insiders are free to sell their shares is  not a bad strategy, because if they continue to hold stock once the lock-up  period has expired, it may be an indication that the company has a bright and  sustainable future. During the lock-up period, there is no way to tell whether  insiders would in fact be happy to take the spot price of the stock or not.

Let the market take its course before you take the plunge. A good company is  still going to be a good company, and a worthy investment, even after the  lock-up period expires.

The Bottom Line

By no means  I am suggesting that all IPOs should be avoided: some investors who have  bought stock at the IPO price have been rewarded handsomely by the companies in  question. Every month successful companies go public, but it is difficult to  sift through the riffraff and find the investments with the most potential. Just  keep in mind that when it comes to dealing with the IPO market, a skeptical and  informed investor is likely to perform much better than one who is not.

Happy reading and Go beat the Market!

Monica.

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5 responses to “Tips for Investing in Initial Public Offering (IPOs)

  1. ummy mwinyirunga

    March 22, 2012 at 5:06 pm

    Mmh you make me think twice about my ipos. Thanx. I loike the article

     
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    May 7, 2013 at 4:16 am

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