IPOs have unique risks, so remember the following five points when investing in one.
First, objective research is a scarce commodity.
Private companies aren’t open books. Keep in mind that they write their own prospectuses. Search for past press releases and financial, industry and competitor information.
Second, pick a company with strong brokers.
Quality brokerages can afford to be selective. Find a company with a strong underwriter, the intermediary between the companies and investors.
Buying pre-IPO shares may be easier with smaller brokerages. Larger brokerages will not allow a first investment to be an IPO.
Third, always read the prospectus.
It lays out a company’s risks, opportunities and intentions. Using a stock issuance to repay debt is a bad sign. Look for money that goes to research or marketing. Also, study accounting figures to see if the company’s earnings outlook is realistic.
Fourth, be cautious.
Some IPO investors can only buy big investment companies’ leftovers. Consider the reason why there’s an abundance of some stock available.
Finally, wait for the lock-up period to end.
The lock-up period lasts between 3 and 24 months, during which underwriters and company insiders cannot sell any shares. It’s a good sign if underwriters and insiders hold their stock once the lock-up period ends.
Remember, it’s difficult to sift through investments. A skeptical and informed investor has an advantage with IPOs.