How to Determine whether to Invest in an IPO

At the end of the 1990s, IPO investment (i.e. a private company's initial public offering of stock) was a spotlight topic in the mass media where most IPOs were portrayed as dream investments available only to a select few. As a result, many investors flocked to IPOs, hoping to enter the ground-floor of mostly high-tech companies with rapid growth potential, and hoping for large and quick profits.

This rush to market, however, more often than not produced mixed results. While some IPOs became stellar performers, many turned out to be lackluster or outright failures.

Because IPOs are generally difficult and highly uncertain investment vehicles, there are questions that investors should ask before entering this sometimes volatile market:

Why Do IPO Shares Have Such Limited Availability?

Usually only a limited number of broker-dealers are invited by a private company to underwrite their IPO. This is coupled with the fact that these select broker-dealers, in turn, reserve their highest profile IPOs for their top clients.

Note that, in rare cases, wealthy broker-dealer clients are so exclusive that they're allowed to invest in new stock offerings before the IPO.

Can an Average Investor Become an IPO "Insider"?

Because of the volatile and speculative nature of the IPO marketplace, brokers place fairly high admission standards on potential investors. Requirements may include an investor's income, net worth, risk tolerance, and investment objectives.

Brokers may also require a specific minimum cash investment balance.

Can Average Investors Gain Access to IPO Statistics Exclusive to Select Investors?

Because of the secretive nature of IPO investing, average investors should educate themselves by doing the necessary research. There are IPO market information resources that are easily available to average investors, and provide knowledge that could bring them closer to the knowledge of the select few.

Average investors can subscribe to online (and offline) newsletters for gossip, rumors, and news surrounding IPOs.

What is the Value of an IPO's Prospectus?

An IPO prospectus can best be described as a more highly detailed company brochure. Most (if not all) can be easily acquired online via the SEC's Web site or FreeEDGAR.com (at http://freeedgar.com/). Prospectuses usually contain the most basic information about a company. The most valuable information gleaned from a prospectus can mostly be obtained by "reading between the lines."

When reading an IPO prospectus, questions to consider might include:

How does this once private company compare to competitor companies that have been publicly traded for a longer period of time?
Who is on the IPO company's management team? Read the prospectus profiles and search online for business news from responsible sources about these individuals.
Why has this private company decided to offer shares to the public for the first time? This may be the most difficult information to uncover.
Does the prospectus specifically state how the company intends to allocate most of its money? How much will be used for past debt versus future growth and development plans, including R&D, advertising, and capital formation?
Does the prospectus specifically state how the company's current annual revenue compares to the previous year's revenue?
Does the company rely on only a few major clients and/or only a few major suppliers?
Who is the company's target market? Will it be large enough to sustain sales and continue to grow?

When Should You Invest in an IPO?

IPO investors have different tactics when purchasing shares. Some investors wait for a short period of time after the often volatile first day of trading. Others wait as long as 25 days after the stock's first trading day, when most new issue analyst research reports usually become available to the public. Most of these types of reports are often filled with marketing embellishments. However, one may find important revenue and earnings projections that weren't available in the prospectus.