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March 26, 2000
The big buzz around town seems to be about one of the hottest sectors in investing and that is the IPO (Initial Public Offering). Everyone is asking, "What is the IPO this week?". Before you leap into the IPO of some unknown stock that you received a "hot tip" about from your Uncle Louie consider these factors.
- What is an IPO?
- Offering Price Vs Open Market Price
- How does an IPO fit into your overall investment strategy?
What is an IPO?
IPO stands for Initial Public Offering. An IPO is when the stock of a corporation is offered for the first time to the general public to buy it and allows the public an opportunity to own a percentage of the corporation. The IPO of a corporation is usually used to raise capital for various needs. Prior to the IPO, the stock of most corporations is privately held through the original founders, executives and initial venture capitalists. At the IPO, the corporation and sometimes the founders, executives, and the initial venture capitalists sell their shares to the public.
Offering Price Vs Open Market Price
The offering price of an IPO can be very different than the open market price of the shares. Purchasing the IPO at the offering price means that you buying the stock at a predetermined price set by the corporation and the underwriters of the IPO before it trades on the market and is subject to the standard bidding and asking procedures that normally drive the price fluctuations of a stock. An example would be as follows:
You buy XYZ stock at the offering price of $10 per share before the stock is actually open to the public market. On the day that the stock opens (is available to the open market/public), it has been bid up to and is selling for $20 per share. The people who could not obtain shares at the offering price must pay $20 per share (the open market price) at the opening of the stock.
Of course, sometimes the stock actually will trade extremely higher than the offering price and sometimes the stock will trade lower than the offering price.
Obtaining the IPO at the offering price can be done through your stock broker depending if you meet the criteria they have established for investing in IPOs and if they are participating in an IPO of your choice.
How does an IPO fit into your overall investment strategy?
IPO investing is not for the beginner investor. Most people can not purchase the stock of an IPO at the offering price and many of the IPOs have selling restrictions placed upon them even if you can get in at the offering price. The risks of investing in an extremely volatile IPO are obvious. You get excited about the prospects of making some fast money and you buy at the inflated opening price only to watch the stock tumble 20-30% right after you buy it. Investing in IPOs are for people who are willing to commit a small percentage of their portfolio on risky investments and for people who have a high tolerance to risk and can afford a complete loss of investment capital placed in the IPO. We have all heard about the 28 year old down the street that picked up a winner IPO and made thousands of dollars, the stories you don't hear are about the many people who bought an IPO at the wrong time and lost BIG. While IPOs are risky and not for the faint of heart, if you are a seasoned investor and have the opportunity to pick up the IPO at the offering price, you may be well rewarded. Be sure to do your due diligence and research the stock to see if it makes sense for you in your overall investing strategy.
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