Updated on July 23, 2024
IPO or initial public offering of shares. A term that the vast majority of investors will come across after some time. Whether you are a long-term investor or a day trader, you should know what this term actually means. You can make good money on shares from the initial public offering of shares. How? And how can you actually get such shares? You will find that and much more in this article.
IPO: What is it?
In order to explain to you how trading with such shares actually takes place, we will first look at what this term means. IPO is an abbreviation of the English term Initial Public Offering. We can translate this into Czech as “First public offering of shares”. It is a situation when a company decides to offer its shares to the public for the first time. This means any investors who decide to invest in that company. So maybe you too.
There can be several reasons why companies decide to take such a step. As a rule, it is about financial reasons, when the company needs support in its plans for its own development. So if he has one, but does not currently have enough free funds, he can take several steps. The first thing you probably think of is going to the bank and taking out a loan. But this is not always the ideal way. Mainly because the interest rates can be too high for entrepreneurs.
Another possibility is the issue of bonds. In such a case, however, the company is in the role of debtor, when it must repay the principal and interest to the owners of its bonds within a certain period of time. Well, then there is a third option. That is, the issue of shares. Not just that, of course. On the basis of these securities, the company partially relinquishes control over itself in favor of the shareholders. And in addition to the shareholders, it also has certain obligations that need to be fulfilled. Maybe pay them a dividend. So if the company bets on dividend stocks.
Preparations for the IPO
If the company in question decides on this third option, i.e. on the issue of its own shares, which it intends to offer to the public, it usually has a long way to go. The process of preparing for an IPO is not at all simple, as it consists of many points that must be fulfilled. According to the BCPP ( Prague Stock Exchange ), the following points are included in this process:
- selection of the issue manager and other members of the implementation team
- selection of the market for the implementation of the IPO
- thorough examination of the company (due diligence)
- internal valuation of the issuing company
- convening the general meeting
- preparation of the emission project
- negotiations with the organizer of the regulated market
- presentation of the company to investors (road show)
- decision on the issue price of shares and their allocation among investors (pricing)
- admission of shares to trading on a regulated market for investment instruments
In addition, it is often necessary to decide whether the company meets the requirements for the given stock exchange. This means whether it prepares financial statements according to the IFSR (International Financial Reporting Standards) standard and whether it has a sufficiently transparent ownership and organizational structure. If the company does not meet this requirement, it must correct everything before entering the stock exchange. It is therefore not surprising that the IPO preparation process can drag on for several years.
Timing of the IPO
However, the entry to the stock exchange itself does not have to be delayed only by the preparation. It can also be strategic timing. It is not always the right time to offer shares to investors. In general, investors are more interested in stocks during times of economic growth. Conversely, when the market falls, they lose interest in stocks and prefer to rely on precious metals to preserve value. So if the management of the company finds that it is not the right time to go public at the moment, it can mean prolonging the whole process.
Of course, investors are most interested in the final stages of the entire project. That is, the period when all formal and legislative steps have already been completed. That is, the moment when the entry to the stock exchange is officially announced to the public, the preliminary share price is set and when securities are officially listed on the stock exchange. And together with that, their sale to individual investors is also connected.
How IPOs can be traded
Are you wondering how you, as an investor, can purchase an IPO share? Basically like any other trading instrument. You can get it from some online brokers. These include, for example, the Exante brand . You can also use the services of individual investment banks or online investment portals.
brochure
The first thing you will be interested in as an investor is the prospectus. This is an extensive document that the company publishes just before the start of the subscription period. This should familiarize you with the emission conditions and also with the company itself and its activities. Basic information required by the relevant regulatory authority should be published here. So if the company decides to list its shares on the Czech stock exchange, the prospectus will be approved by the CNB (Czech National Bank). For US stock exchanges, the prospectus will be reviewed by the SEC (United States Securities and Exchange Commission).
However, we must point out that the fact that the regulatory body approves the prospectus does not mean that it recommends the securities for investment. It only shows that the document meets all the formal requirements. So it contains everything it should contain. However, the final investment decision belongs directly to the investor.
Subscription period
Let’s clarify one more term. And that’s the subscription period. This means the period after which those interested in the shares can submit their orders. Potential investors usually have a week or two to do this. Therefore, if you are interested in IPO shares, you must open an online form where you fill in the details of your request. You must pay attention to the fact that in order for your order to be included in the order book, you must fill out the form correctly. Otherwise, your order will be rejected.
However, even if you fill it in correctly, you still haven’t won. Not every applicant for shares is accepted. And this in the case when interest in IPO shares exceeds their volume of securities. First of all, companies usually prefer large investors who promise to hold shares for the long term. This ensures their stable price. In general, it can therefore be said that IPO shares are less accessible to small individual investors than to larger institutional investors.
If demand exceeds supply, the company may choose to exercise a raise option within 30 days of the IPO date. This will allow her to increase the volume of shares by up to 15% compared to the original plan. However, if the offer of investors is still higher than the offer of shares, the allocation of shares is decided by a random draw. This is why it can happen that the company allocates shares to some investors and not to others.
Rather than long-term investors, IPO stock trading is beneficial for short-term traders. And this is primarily due to the IPO effect, as well as the lower performance of companies that have just offered their shares.
IPO effect
Short-term traders get into IPO trading mainly because of the IPO effect. This refers to a situation where, shortly after the issue of shares, their price rises sharply. And this is the right time to sell them. Because these traders can make very good money from it. This period does not last long, as a rule, it is a few hours after the release of securities on the market.
Why is this happening? The reason may be an undervalued exchange rate. So the stock is sold at a lower price than what the market will create in those few hours. Undervaluation of shares is not naturally the goal of the company, which on the contrary tries to get as much money as possible through sales. But they have to find a value that investors are willing to pay for the share. However, this effort to correctly price shares may not always be successful. As a result, we will come across undervalued, overvalued, but also correctly valued shares on the market. However, the goal of investors who intend to profit from the IPO effect is to find such securities that are sold below the price.
Another cause of the IPO effect lies precisely in the activity of short-term traders who sell their IPO shares. They logically try to sell these securities at a higher price and thus make a profit. This also increases the price of shares immediately after they are issued. However, it depends on the demand of other investors.
Reduction in the performance of companies
When we observe market regularities, we find that companies that have gone public tend to underperform other companies with similar market capitalizations. And they are not able to increase it even several years after the IPO date. As a rule, this stagnation lasts 3 to 5 years. The reason may be that the team overestimated the company’s valuation before the IPO took place. Alternatively, the fact that the company’s management did not choose the right time to enter the market. As we have already mentioned, it is necessary to find such timing so that investors are interested in the shares. And ideally at a time when the economy is booming.
Are IPOs worth trading?
So the question arises – are IPO shares worth trading? Right from the beginning, we promised that you can make a lot of money from IPO trading. And we stand behind that. This is due to the IPO effect, which we imagined a moment ago. So if you choose the right stocks, you can expect a nice profit as a short-term trader. Note, however, that not all stocks are necessarily undervalued. And then the IPO effect may not occur.
At the same time, we recommend not to neglect fundamental analysis when trading IPO shares. You can take freely available information and a prospectus to hand. It is this that is a crucial document for investors at a time when they are deciding whether it is a good idea to buy the given shares. But when it comes to technical analysis, it won’t help you much. And for one simple reason. As these are newly issued shares, you will not find any price history. Therefore, assets that have been moving on the market for some time are more suitable for technical analysis.
But long-term investors have to reckon with the fact that they probably won’t win completely with IPO shares. And this is mainly due to the phenomenon where companies show lower performance for several years after their IPO. Therefore, we recommend that these investors rather hone in on the shares of companies that have been on the market for some time. In addition, you will have the advantage of being able to use technical analysis tools as well.
