An Initial Public Offering (IPO) is the first opportunity for stock investors and traders to get exposure to a company's shares.
They tend to produce volatile stock price movements on the day of their listing and shortly afterwards, which may result in significant gains and losses.
If you are interested in buying IPO shares in Australia, this blog will help you learn about initial public offerings, their benefits and risks, how to invest in IPO stocks in Australia for beginners, and more.
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1. What Is An IPO?
An IPO is when a private company becomes public by selling its shares to the public through a new stock listing.
It helps companies access investors' capital for working capital, growth, expansion, or debt repayment.
The Australian Stock Exchange regulates the listing of stocks and securities in Australia. So, companies that plan to bring their IPO must conform to the ASX listing rules.
2. Who Sets The Price Of An IPO?
Investment banks set the price of an IPO.
The company decides the number of shares it wants to sell to the public. Then the appointed investment bank evaluates the business.
Next, the company announces the initial stock price. After it lists on the ASX, the public can trade in that stock.
3. Who Can Invest In IPOs?
Before applying for an IPO, you must check the eligibility criteria. You can invest in an IPO if you meet the following conditions:
You must be 18 years or above
You must hold an Australian or New Zealand residency
You must fulfil the investment limits of each IPO
4. How Do You Start Investing In IPO Stocks?
Here are the steps to start trading IPOs:
Step 1: Learn How IPOs Work
Before you apply, you must first learn the basic IPO terminologies and how it works.
Step 2: Open An Online Stock Trading Account
You need a live trading account if you wish to trade in IPOs on live markets. Compare online share trading accounts that offer IPOs and choose them based on their fee, convenience, and security.
However, opening a trading account doesn't guarantee you access to all upcoming IPOs.
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Step 3: Explore IPOs And Choose Which One To Trade
You can find the list of upcoming IPOs on the ASX, or you can even find it on your stock broker's website. Many trading platforms, such as eToro, allow you to explore upcoming IPOs along with in-depth expert analysis.
The trading platform offers extensive trading features, social trading tools, and copy trading to imitate the trades of other famous traders.
Step 4: Request The IPO Application Form From Your Broker
Once you have selected the IPO you wish you trade, the next step is to start the application process. You need to get the IPO application form in the prospectus.
You can get the same from your broker. While applying, you must adhere to the minimum and maximum number of shares as defined in the prospectus.
Step 5: Fill Out The Form And Submit It
The last step to applying for an IPO is to complete the form and send a cheque via mail.
Alternatively, you can organise a BPay, or directly deposit the investment amount to the IPO provider company in the specified account.
You must complete the necessary documentation and send them within a set duration (usually three weeks) to ensure you take advantage of the opportunity. The float date determines the number of shares you have been allotted.
5. Can Beginners Invest In IPO?
An initial Public Offer is one of the best ways to gain partner ownership in a company quickly. Applying for an IPO involves simple steps that even a newbie can do easily.
Usually, investing in an IPO in the hope that it can earn them a lot of money in a short period tempts most beginners.
However, it requires tactful and timely decisions to reap good returns. There is always risk involved, and not all IPOs are successful.
As the stock market may be tricky for novices, they should study the market, examine the behaviour of the stocks, and the factors that move the share prices.
Valuable Tips for Beginners for a Sensible IPO Investment:
Determine your investment priorities, risk appetite, and financial goals before you select the appropriate IPO.
Do a detailed study of the upcoming IPO and compare their growth and their Price to Earnings (PE) ratio. Ignore the companies with a high PE ratio.
There are no guaranteed returns. So, don't borrow money to invest in an IPO. If the stock price falls after listing, you will lose money and have to pay the interest rate on the borrowed money.
Getting caught in the excitement of purchasing a new IPO is easy. However, understand the investment risks, the unpredictable nature of markets, and your loss tolerance ability before you decide to buy it.
To open an online trading account, compare the fees and features across different stock brokers. Look for a broker that charges you low costs and offers an innovative and convenient platform to place trades online.
When choosing an IPO, don't go after the big names creating hype in the market. Instead of relying on stock brokers or investment banks, rely on your research about the company. Understand the company's facts and figures in the IPO prospectus and focus on its growth potential before moving.
It is better to wait till the lock-in period to buy IPO stocks ends. This way, you can better evaluate the profitability of the stock and save yourself from early volatility.
Make sure you study the market trends, as the IPO performance often follows the trend. A fundamentally strong IPO has a higher chance to perform well in a bullish market and help you earn bucks quickly.
Some promoters dump their shares after the lock-in period, which causes the price to fall drastically. Hence a thorough background check on the company's promoters is essential.
Avoid getting carried away by the hype surrounding an IPO listing.
Always seek the help of a professional financial advisor before making any investment decision. Investing carries risk. The above are just some general options for educational purposes. All these options come with risk. This is not financial advice.
6. Does Investing In IPOs Yield A Great Return?
Yes and No. IPOs can deliver good returns, but if you look at the statistics, only a few IPOs have succeeded in giving manifold returns. First-time retail investors should not get carried away by looking at substantial listing gains or oversubscription figures.
You may make gains from an IPO provided that you check the following aspects of the company before investing:
Core values, policies, and objectives
Promoters
Past performance and credibility
Market growth opportunity of the segment in which it operates
Positioning of the company among its peers
Competitive landscape
Percentage of market share it holds
Future expansion and growth projects
Potential to grow into a more prominent company
Current valuation
Thus, you must do extensive research and determine the risk-reward ratio of the investment before you consider one.
Always seek the help of a professional financial advisor before making any investment decision. Investing carries risk. The above are just some general options for educational purposes. All these options come with risk. This is not financial advice.
7. Can You Sell An IPO Immediately?
You can and cannot sell the IPO immediately. It depends on the type of investor you are.
Retail investors who buy shares of the company right after it gets listed are allowed to sell their shares instantly after buying them. Thus, they can invest in whichever company they like and switch to other companies for a profit when the stock price rises.
However, initial investors such as employees, institutional investors, and other private investors have to hold their stocks until the IPO lockup period after listing before they can sell them on the market. It prevents them from selling the stock immediately.
8. Why Should You Not Invest In An IPO?
If you are thinking about why an IPO is risky and whether it is worth investing in, then here are a few reasons that confirm it:
Investment bankers, promoters, and underwriters are the salesmen of IPO. Sometimes they create intended hype and baseless opportunity among investors.
IPOs are relatively expensive. The company might have launched it at a low price, but it becomes costly when it trades in the market.
IPOs are highly volatile, and that's what leads to massive gains or losses. When the IPO launches, it is often a market attraction centre. You can see a lot of trading activity in the stock for a couple of days after it goes public. The supporters and opponents try their best to move the stock price in their favour.
Most IPOs tend to underperform and give negative returns. You would understand it if you saw the long-term returns from an IPO.
If the IPOs don't have a profitable and maintainable model and the market doesn't find the business worthwhile in the long run, or if the company's ongoing debts exceed its earnings, the IPO will likely fail.
IPOs don't have circuit breakers. Circuit breakers are a protection mechanism that defines the limit beyond which the stock price can't fall. Without it, the price of the IPO may drop drastically, resulting in substantial losses.
9. How Do You Find A Good IPO To Invest In?
Several factors determine whether an IPO is worth investing in or not. Your investment strategy, goals, and risk tolerance, to name a few.
To increase the chances of profiting from your IPO investment, you must read the prospectus thoroughly and evaluate the pros, cons, and inherent risks.
The following factors will help you understand whether a business is reasonably valued and could be a sound investment:
The projected strength of the company's balance sheet after the float
The long-term growth prospects
The expected earnings of the company
The significance and the growth potential of the sector it operates in
IPO investment may only satisfy you if you focus on tried and tested companies. However, if you prefer stocks with growth potential, IPOs are an option, but still risky.
10. Does The Stock Price Usually Drop After IPO?
The decline in the stock price after it goes public happens due to the following reasons:
When IPO marketers hype the valuation and stock price to a level that the market isn't ready to accept, the stock is overvalued and corrected from that price.
If the company can't meet the industry expectations and fails to perform in the financial market based on its quarterly results.
If the company fails to meet the industry standards compared to its peers.
When the economy is on a downward trend, then also IPOs tend to fall after their listing on the stock market.
If the public's sentiments, including the media, analysts, investors, and the general public, aren't optimistic about the stock, then the stock price may drop after IPO.
The rapid selling from initial investors after the lock-in period could also negatively impact the stock price after IPO.
In the above situations, you must analyse the situation, understand the actual worth of the stock, and wait for the price to stabilize before investing in it.
11. Are IPOs Better Than Stocks?
IPOs could bring better returns than stocks, but not all IPOs are worth investing in. You should only consider investing in an IPO if you're confident in the company's potential for success and valuation.
One drawback of IPOs is the lack of historical data, making it harder to predict their future performance than established company stocks. Additionally, getting an allocation in an IPO can be challenging; unlike regular stocks, you can buy immediately.
In any case, whether you're looking at IPOs or stocks, it's important to research, stay updated on developments, and analyse future trends if you plan to hold them long-term.
12. Is Investing In IPO Always Profitable?
There is no way to ensure that an IPO will be profitable in the long run.
How it will perform and how much profit you make depends on the company's performance, fundamentals, growth potential, and current and future demand.
The statistics show that out of 10 initial public offerings, only 1 or 2 companies are profitable and make money. You may earn good profits from an IPO if you thoroughly research and invest in the right company.
13. Is It Wise To Invest In IPOs?
Investment in an IPO depends on your financial objectives and risk appetite. Controlling your emotions and not just buying them if it is overhyped is essential to make the right investment decision.
IPOs could be an excellent profit-earning opportunity if a company has healthy financials and attractive future growth prospects.
Once you learn how to differentiate between hype and the company's actual strength, you will have better chances of getting good returns on your investment.
Besides the above, comparing the rewards and risks of IPO investing also helps determine whether it is worth trying.
Rewards
It helps you participate in the initial growth years of a business.
It enables you to achieve long-term goals such as a house purchase, retirement, etc.
An opportunity to buy a stock at a discounted price that, if missed, won't come again.
Risks
Lack of information. As private companies introduce IPOs, they don't have stringent disclosure norms.
Investors must refrain from relying on third-party views to learn about its performance. Such beliefs can be manipulated and hide critical information that can negatively affect investors' interests.
After the lock-in period, promoters may sell the fundamentally weak company's shares, book their profits, and exit the stock. That's why investors must do proper research on the company's promoters and its growth prospects.
Some companies use the investor's capital to reduce their debt instead of using it for their research and development. It can pose a considerable risk for investors.
That's why it is essential for investors to always read the prospectus and find out the real reason for IPO before putting their hard-earned money into it.
14. Frequently Asked Questions (FAQs)
What is The Minimum Amount To Invest in an IPO?
The minimum investment amount varies between IPOs.
When a company launches an Initial Public Offering, it specifies the minimum number of shares or IPO bid size an investor can apply for.
For instance, if a company specifies the IPO bid size as 100 shares and the investor wants to buy over 100 shares, they can apply for multiples of 100 only, i.e., 100 shares, 200 shares, 300 shares, and so on.
However, there can be limits on how many shares a single investor can buy or the minimum number of shares they need to buy to participate in an IPO.
How is The IPO Price Determined?
A company wishing to launch an IPO and list on the ASX must first lodge an IPO prospectus on the ASX. It is a lengthy document that summarises its business and financials.
Once approved, the company decides the number of shares it wishes to sell to the public. It nominates an investment bank to perform a valuation of its business and set the IPO price.
Once this is done, the company releases its IPO details, such as minimum investment and an initial share price. The investment bank reaches out to institutional and retail investors to spread the news about the upcoming IPO and sell it to them.
The public can begin trading shares when the IPO gets listed on the ASX.
When Can You Sell The IPO Shares?
You can sell the shares only when the IPO gets listed on the ASX exchange.
Based on past 5-year data, 50% of IPOs perform well in the long term and deliver good returns to investors.
(Past performance does not guarantee future results.)
What Happens If an IPO Fails?
Every company, whether small or big and old or new-age economy, that launches an IPO expects to make money in the market. When successful, an IPO raises immense funds to keep the business operational.
However, the Initial Public Offering is considered a failure if the company's stock price is listed at a higher valuation. In this case, the company's founders fail to sell adequate private shares to sustain itself.
Investors get lured into all types of IPOs to earn listing gains. Some investors may score handsome gains in a bull market; however, the valuation will only sustain if the company smartly progresses.
In a failed IPO scenario, companies will have difficulty attracting new investors. It may require them to tighten their budgets and pause new projects until the IPO stabilises.
How Long Does It Take For an IPO To Close?
Transiting from private to public is demanding and expensive for the IPO issuing company.
The amount of time required depends on various factors, including the organisational level of the IPO management team.
The IPO process generally lasts over a year for the company to complete its public debut. It starts with an internal evaluation of the company's readiness, corporate governance structure, management, and the potential interest of investors.
On approval of the company's IPO prospectus, the stock exchange will provide a date for the listing. Once listed, the market determines whether it is the right listing price, leading to its success or failure.
What Percent of IPOs Succeed?
As per a Nasdaq analysis, since the 1980s, companies that went public have had an IPO success rate of around 20%. It implies that 80% of companies that go public become unprofitable after debuting on the stock exchange.
Do IPOs Always Go Up?
Several examples of IPO stocks rose abruptly on debut, but IPOs don't always go up.
For instance, Riskified and Robinhood IPO stocks fell on their first trading day. Whether the stock price rise or falls after an IPO depends on various factors.
A successful IPO indicates robust demand for the stock as investors see a bright future in that company.
On the contrary, an IPO that fails on debut might suggest that the stock's valuation was overpriced compared to what investors expect while reading its prospectus and understanding its business.
What Are The Disadvantages of Investing in an IPO?
Some of the significant disadvantages of IPO investing are:
Are IPOs a Good Investment?
IPOs have gained much popularity among different types of investors and often garner attention from the media. There have been many companies that got successful and generated massive money after getting public.
Though it is believed IPO holds the promise of riches, it doesn't guarantee success and can lead to substantial risks. Their volatile price movements make them appealing to most investors. However, it can lead to huge returns or huge losses.
Companies will price the IPO deal in a way that enables their price to rise on launch. For investors, it is an opportunity to buy a stock at a discount and preferably more shares than they could after it goes public.
IPO investors can only be profitable if they do extensive research and solid analyse the prospectus before investing. If done wisely, IPO investing can give a head start in the stock that pops on debut and be a massive boon for the company and its shareholders.
What Is The Average Return After an IPO?
In 2019, the Australian IPO market generated an average return of 35.2% on December 31. This is the fourth time in the past five years that the IPO market has given better returns than the ASX 200 index. (Past performance does not guarantee future results.).
Despite the all-pervading economic impact of the coronavirus, the IPO market recovered strongly in the mid of 2020 with a rise in market listings.
The ASX reported 74 new listings in 2020. Despite challenging market conditions, their overall share price performance has been positive, and many even recorded robust year-end gains. Of 74 new entrants, 49 posted an average year-end profit of 34% in 2020.
Furthermore, in a post-coronavirus rebounding environment, a healthy pipeline of new market entrants is scheduled on the exchange in the coming time. It shows the strength of Australia's economy and positive investor sentiment.
What Happens To IPOs Over The Long Run?
According to Nasdaq data, most new companies are unprofitable when they launch their Initial Public Offer. Since the 1980s, unprofitable IPOs have grown from 20% to 80% of the total IPOs launched yearly.
The long-term returns of IPOs vary significantly. Just 29% of IPOs listed three years ago have seen their prices double or triple. The majority of IPOs have performed worse, falling behind the benchmark ASX index by approximately 10% and ending up with negative returns.
Here are a few findings based on the long-term statistics:
Companies with higher sales on their IPO launch date perform better than those with less established market penetration and meagre sales.
Regardless of the profitability, companies with sales below $100 million are likely to underperform the market after IPO. On the contrary, new entrants with more sales outperform over three years.
Unprofitable companies show inflated results. Those making higher sales outperform, and companies with small sales underperform more.
This shows that it is difficult for companies to enter new markets. However, the ones with growing revenues and profitability have better chances to reap rewarding returns.
Why is Investing in IPOs Risky?
The unpredictability of the new listing and limited financial information and operation history makes trading or investing in IPO shares riskier than established ones.
Individual investors must understand the associated risks of IPO investment before considering them.
Some of The Significant IPO Risks are as Follows:
The stock price may drop after the first-day increase. So, the main risk in IPOs is "no assurance" of its future growth on the stock exchange. If the business isn't stable, doesn't have secure plans, and fails to yield considerable returns, it will fall substantially.
If you go by records, most new entrants have been unsuccessful due to their lack of planning to produce sustained profits. So, investors should refrain from assuming that an IPO is profitable or ever will be.
Limited operation history makes it tough to assess a company's value. This can lead to incorrect valuation estimation and prevent investors from making the wrong investing decision.
Due to fluctuating investor sentiment, you may see high volatility and sharp price movements in the initial trading days of an IPO. Your investment can be at increased risk if the share price falls massively. Also, due to the heightened volatility, regulators suddenly freeze trading in a specific stock. It can be more troublesome for investors.
Over-Valuation Issues are another risk that investors may need to face. Due to the increased popularity of IPOs, there are higher chances for an over-valued offer.
This can cause investors to incur losses if the share price corrects to a fair level. IPOs launched during bear markets could be offered at fair valuation - below their intrinsic values.
Other risks to watch out for:
Confidentiality and trade secret issues
Insider trading by the directors and new investors can harm the company's performance.
The fallout from dissatisfied shareholders
What Factors Impact an IPO's Price?
Determining the correct value is a critical step when investing in an IPO. It helps in identifying whether the IPO is worth investing in.
The correct valuation can help you invest in fairly-priced IPOs and earn rewarding returns. At the same time, incorrect estimation can cause substantial losses.
So, when figuring out an IPO's valuation, here are seven key parameters to consider when evaluating the company:
The Overall Market Conditions (Bull or Bear market) - The demand and possibility of listing gains for IPOs are usually high in bull markets and vice versa.
Financial Stability - A company with solid financials tends to see a greater demand (and price) for its IPO.
Growth Potential - Suppose investors believe in the company's business model and ability to grow it. In that case, they will be ready to pay more for shares.
Competitive Landscape - If there is more demand for shares than available, the IPO will likely launch at a higher price.
Sectoral Volatility - IPOs in specific sectors, like technology, usually see more price fluctuations.
The Offering Size - An extensive offering usually leads to a lower price per share and vice versa.
Industry Comparable - Compare the share price and market capitalisation of other companies within the same industry. It can serve as a benchmark for the new IPO.
Should You Participate in an IPO?
The high fluctuations in share prices that have the potential to offer substantial gains can also result in huge losses. That's the reason the decision of whether or not to participate in an IPO is very crucial.
Here are a few action steps to help you make an informed choice.
Research the company. It includes what it does, how long it has been in business, and its track record. IPOs from public sector enterprises are relatively safer than those from private companies.
Understand the associated risks or red flags.
Study the company's financial statements to understand how much money it is making and its expenses.
Compare the company's stock to other stocks within the industry to assess its potential upside or downside.
Understand its market demand, including the demand from institutional investors, who buys large blocks of shares, and the demand from individual retail investors.
The stock price can increase if the demand for a company's shares exceeds the available ones. Such a company can sell more shares and raise more money.
Assess the company's ability to progress concerning profitability.
Evaluate its potential to grow and expand its business.
Finally, you should have a strategy for selling your shares.
Carrying out this research can take time and effort for new investors. It is essential to know that you can always purchase the shares once they list on the exchange and start trading.
Usually, post-IPO, the share prices of most companies drop considerably below their offer prices.
How Do You Decide If an IPO is Worth Investing in?
Analysing an "initial" public offer is difficult as less information about the company's operating history is available. Due to this reading, the prospectus is essential to analyse the company.
It includes the following details about the company:
Business
Holdings
Promoters
Objects of the offer (It could be for a partial exit of the current promoters and the strategic investors).
Financials (debt, profit and loss, earnings before interest and taxes, cash flows and reserves, interest coverage, debt-to-equity ratio, revenues, and operating profits, and price-to-earnings and price-to-book ratio per share)
Future growth plans
Here are some questions to assess an IPO and find whether it is worth investing in:
Is the company's debt below 30% or at maximum 50% of equity or total investors' funds, including reserves?
Are the company's earnings before taxes and interest at least four times or more than the interest costs?
If the company's debt is high, find out whether one of the objectives of fund-raising through IPO is to reduce its debt considerably.
Does the company have significant revenues? A company with revenues below Rs. 250 crores is small for most retail investors to invest in.
Are the company's revenues steady or rising over the last few years?
Are the profits stable and substantial, and are their operating margins at least 15% or higher? Companies with operating profits of Rs. Fifty crores or more can be worth investing for retail investors.
Has the company controlled or reduced its debt, or has it been steadily increasing? A significant rise in debt over past years is a red signal. If the debt is growing due to the company's expansion, dig deeper to understand can the company expand in the future without acquiring huge debt.
Is the company generating adequate cash flow from operations to preserve its growth rate?
How resourcefully is the company using its assets?
Is the company generating an adequate return on assets to recover its capital cost of capital? A return on assets of 15% or more is ideal.
How much company's percentage will get listed for public trading or as non-promoter holdings? Promoters must have a minimum 25% shareholding left after the listing as it indicates they have continued interest in the company's performance.
At what price are the shares offered? Companies offered at the P/E and P/B ratios are discounted to the already listed similar larger companies. Generally, a company with a PE ratio over 25 is not ideal for investment.
Always seek the help of a professional financial advisor before making any investment decision. Investing carries risk. The above are just some general options for educational purposes. All these options come with risk. This is not financial advice.
14. Conclusion
While an IPO may appear a perfect money-making opportunity at first glance, delving deeper may reveal hidden flaws.
Realising gains from an IPO investment requires patience and a thorough understanding of the company's fundamentals, valuation, and future growth prospects.
By following the steps and tips, you can confidently invest in IPOs. However, remember to exercise caution and be aware of potential risks that may surface upon closer examination.
If you don't have a share trading account yet, consider eToro, which is used by many investors in Australia and worldwide. You can create an eToro trading account HERE.
eToro Service ARSN 637 489 466 promoted by eToro AUS Capital Limited ACN 612 791 803 AFSL 491139. Capital at risk. See PDS and TMD.
The advice and information on OzStudies.com is in general nature and should not be seen as a replacement for independent financial advice. We strongly encourage readers to consult with financial experts regarding their own financial decisions and investments. Please note that the information presented on OzStudies.com is solely for educational purposes. Every individual's financial situation is unique, and the products and services we mention may not suit everyone. We do not provide financial advice, advisory, or brokerage services nor endorse buying or selling specific stocks or securities. It's essential to know that information might have changed since publication and past performance does not guarantee future results. |
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