There hasn’t been much IPO action lately, since the market has been so uncertain and periodically battered. But that’s going to change at some point. So, it’s worthwhile to note some of the ways IPOs can be useful to you when times are more favorable to these initial public stock offerings.
IPOs fall in between venture capital and established public companies in terms of risk and potential returns. With a prudent plan you can maintain your chances of earning outstanding returns from IPOs while reducing the risk of loss.
Diversify. Instead of buying one new issue, invest in several attractive IPOs, in different market sectors.
Evaluate the underwriter. Some Wall Street firms have a record of backing new stocks that have done well in the aftermarket.
Screen before buying. Learn about the company’s business, management, financial strength and so on. Stick to IPOs with market values above $15 million to avoid truly risky companies.
Insight: Don’t buy an IPO if it’s recommended only by the underwriter. In one study, IPOs recommended by independent analysts outperformed those recommended by the issues’ underwriters by 63%.
Don’t overpay. Savvy investors measure IPOs by “enterprise value”: the market value of the company plus debt minus cash. If an IPO’s enterprise value is 10 times cash flow for the latest 12 months while similar companies trade at enterprise values of 20 times cash flow, this IPO may be well-priced.
