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Four Ways to Vet an IPO Before You Buy

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Every investor will agree that the more you know about a company and its stocks, the more you know about whether to invest in that company or not. Knowledge is power after all. This is especially true with an Initial Public Offering (IPO), perhaps the most vital and vulnerable time in a company’s stock.

Where, exactly, can the average investor find the information required to make an informed decision? The answer isn’t hard to find, but you will need to do some of the work yourself.
By following the steps below, you can personally vet and IPO before you decide whether to buy.

The SEC S-1 Form

When a company first goes public, it is required by law to fill out an S-1 Form with the Securities and Exchange Commission (SEC). The SEC is a federal agency that enforces all federal laws and regulations concerning things such as the stock market and option exchanges. Every S-1 form is available to the public through the SEC.gov website.

The form itself, like most government paperwork, is dense and massive. Consequently, it is also very thorough.  Not only will it have information on the estimated price of an individual stock, but also everything every would-be investor should know about the company including its business model, plans and goals for future growth, and budget.

Related article:  What Is Asset Allocation and Why Is It Important?

The Earnings Report

Any company worth their salt will have an earnings report available, most likely on its website, for public viewing. The earnings report is simply a list of a company’s income and expenditures on a quarterly or annual basis. Usually the form will contain revenue and cash flow as well as projected earnings. Perhaps the wisest thing to do with an earnings report is to take note of where their money comes from and their average annual profit. If profits are growing, it is usually a good sign that the company is as well.

The Underwriter

An underwriter is an investment bank that helps the company assess the value of their shares based on factors such as earnings and total assets. The company signs a contract with the underwriter stating that they will sell their shares to the public. The underwriter then goes to investors and offers to sell these shares. Once sold, part of the money for the sale goes to the underwriter as a commission (up to eight percent).

It is very important to consider the underwriter of an IPO. Some firms are not reputable and may fraudulently miss-price stocks. Most investment banks are easily researched and by searching their history for the success of their other IPOs, you may shed some light on the company’s stock. Another aspect of an underwriter worth scrutinizing is its familiarity with the company and its industry. “Invest in what you know”, the old saying goes.

A Second Opinion

Related Article: Stock Primer for the Novice Investor

It is impossible to know everything about everything, and even the smartest need help. This is why words such as ‘expert’ and ‘specialist’ exist. Investing is risky, and so the opinions of others are valuable. Don’t be afraid to seek them out, and they may help you better understand your situation. After all, would you rather be proven wrong before or after you’ve spent money?

The only real way to minimize risk in investing is to be knowledgeable and patient. An amateur’s first mistake is usually diving right into an investment ‘opportunity’ without any reason other than a ‘hot tip’. The internet provides a great deal of information, and you can use it to your advantage. Plenty of websites offer sound advice without trying to sell you something. Remember to always be thrifty with your money, and realistic with your goals.

What have you invested in lately?

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AUTHOR Derek

My name is Derek, and I have my Bachelors Degree in Finance from Grand Valley State University. After graduation, I was not able to find a job that fully utilized my degree, but I still had a passion for Finance! So, I decided to focus my passion in the stock market. I studied Cash Flows, Balance Sheets, and Income Statements, put some money into the market and saw a good return on my investment. As satisfying as this was, I still felt that something was missing. I have a passion for Finance, but I also have a passion for people. If you have a willingness to learn, I will continue to teach.

7 Comments

  1. First of all, its not an easy process from individuals to apply for an IPO. So its expected that due diligence would be there when someone takes the pain to buy in IPO

  2. SB, you would think people would do their due diligence.. but after the Facebook fiasco I felt the need to write this post.

  3. SB so many people got burned on FB. Why? Everyone thought they knew about the company and still a lot of money was lost. The article was good. Stuff that we all should know about.

    • Jai,

      I think people wouldn’t have got burned if they read any of the SEC filings.. the P/E ration was off the charts and the risks were too big. People got burned b/c they fell for the marketing hype instead of looking at fundamentals.

  4. This is a great list. The S-1 is everything, and I definitely agree that most investors could avoid a world of hurt just by reading through it. I think FB’s was like 150+ pages long. That’s a lot to sift through, but not if you want to put money on the line!

    I haven’t gotten into any IPOs lately, but I was really interested to see Fender go public. Fender is the kind of company I’d love to own, even if music isn’t as hot as social media. I’m hopeful that they’ll reconsider going public in the future. Cool brand in a business that isn’t going anywhere any time soon.

  5. Wow, this is really great information! It’s nice to know that the guess work can be taken out of deciding whether or not to invest in an IPO!


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