Initial Public Offering – Introduction
John Tuld, the C.E.O. of a large “unnamed” investment bank in the movie “Margin Call”, says:
“There are three ways to make a living in this business: be first; be smarter; or cheat.
Now, I don’t cheat. And although I like to think we have some pretty smart people in this building, it sure is a hell of a lot easier to just be first”.
Well, we don’t cheat either, and while we hope that all our usual blog articles can help traders be smarter, this one, in particular, is for those who also want to be first. Our next topic is “IPOs and IPO trading”!
Before we can dive into IPO trading strategies and learn the difference between the ones to follow and the ones to avoid, we must first get an idea of what IPOs are, why they happen and how they work. And in this “part 1” of the article, that’s exactly what we’ll do.
Get comfortable.
Key Notes:
- In an IPO, a company offers its share to the public for the first time
- By having an IPO, a private company becomes a publicly traded firm
- On the day of the IPO, the company shares can be traded through a stock exchange.
Initial Public Offerings (IPOs). What are they and how do they work?
Simply put, an IPO is what a privately held company does when it first “goes public”.
To initiate the process, the company offers its shares to the public for the first time and by doing so becomes a publicly traded entity, and its shares are then listed on a stock exchange.
Before diving into how IPOs work and the process behind them, let’s first take a look at why it is important for both the companies having the IPO and the traders and investors looking to profit from it.
From a company point of view…
Several reasons can motivate a private company to have an IPO. The benefits can include:
Raising capital
IPOs allow companies to raise large amounts of capital in a short period. This capital can be used to fund various initiatives, such as expansion, product development, or acquisitions.
Establishing a public market valuation
IPOs create a public market valuation for the company, which can help attract investors and increase the company’s credibility.A higher valuation can make it easier for the company to borrow money or enter into partnerships.
Improving liquidity
IPOs provide a way for existing shareholders to sell their shares, increasing the liquidity of their investment.This can make it easier for investors to enter and exit the company at their convenience.
Gaining recognition and prestige
Going public can significantly raise a company’s profile and increase its visibility. This can lead to increased customer awareness, media coverage, and partnerships.
M&A opportunities
Public companies may find it easier to engage in mergers and acquisitions. Other companies may be more interested in acquiring a publicly traded company due to its established valuation and liquidity.
From a trader/investor point of view…
Traders like IPOs for several reasons and these include:
Potential for high returns
IPO trading can offer the potential for high returns, especially for companies in high-growth industries. When a company goes public, its shares are often priced below their fair market value, providing an opportunity for traders to buy in at a discount.
Volatility
Stock IPOs tend to be more volatile than seasoned stocks, which can provide opportunities for traders to profit from price swings.
Liquidity
IPOs of large, well-known companies typically have high liquidity, making it easy for traders to buy and sell shares.
Short-selling
IPO traders can also profit from IPOs by short-selling the stock if they believe it is overvalued.
Speculation
IPOs can be subject to speculation and irrational exuberance, which can lead to exaggerated price movements. Traders can take advantage of these market inefficiencies when IPO trading.
New investment opportunities
IPOs provide traders with access to new investment opportunities, particularly in emerging industries or companies with innovative products or services.
Momentum trading.
Traders can ride the momentum of an IPO by buying the stock after it has gone public and selling it when the price reaches a certain target.
Technical analysis
Traders may use technical analysis to identify trading opportunities in IPO stocks, such as breakout patterns or support and resistance levels.
Key Notes:
- An IPO is a complex process that includes several steps
- There are strict regulations and controls a company must adhere to to become publicly traded.
- In an IPO, shares are allocated to investors according to their bids.
How does an IPO work?
Having an IPO is not as straightforward as one might think; it is a process that involves several key steps.
IPO key steps
Underwriting
Investment banks act as underwriters, managing the sale of shares and advising the company on the IPO process.
Prospectus Publication
The company files a prospectus with the Securities and Exchange Commission (SEC) or a comparable regulatory authority. This document provides detailed information about the company, its financial performance, and the terms of the IPO.
Investor Roadshow
The company and underwriters embark on a roadshow to meet with potential investors and promote the IPO.
Pricing and Allocation
The underwriters determine the offering price based on demand and other factors. Shares are then allocated to investors based on their bids.
Listing on Exchange
The company’s shares are listed on a stock exchange, making them available for public trading.
What is a pre-IPO then?
Pre-IPOs (Pre- initial public offerings) are private placements of shares in a company that has not yet gone public.
These offerings are typically made to a small number of accredited investors, such as venture capitalists and hedge funds.
Pre-IPOs can be a way for companies to raise capital without having to go through the formal process of an initial public offering (IPO).
Now that we understand and have a clear picture of what IPOs and how they work, we are all ready and prepped to find out in a little more depth what the advantages and disadvantages of IPO trading are, and to finally dive into everyone’s favorite part: the strategies!
Hope this helps!
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