IPO is short term for Initial Public Offering, is when a company issues common stocks or share to the public for the first time. It is usually done to raise capital in order to expand their business without borrowing money from the financial center. Once a company is listed, it is able to issue additional common shares via a secondary offering, thereby again providing itself with capital for expansion without incurring any debt. This ability to quickly raise large amounts of capital from the market is a key reason many companies seek to go public. Buying IPO is just a click away nowadays.

Unless you know a lot of the company, it is best to avoid initial public offering (IPOs) which normally practice by value investors. While IPO are often marketed as growth stocks, their long-run performance has been dismal. Generally speaking, IPO are anything but growth stocks. Over the year from 1980 through 2005, more than 7000 IPOs are issued and the average three-year post IPO performance is 20% below corresponding market returns according to Professor Jay Ritter and Ivo Welch.

initial public offering-IPO

Initial Public Offering-IPO

The most important driver of growth in stock price is growth in earnings. While an IPO is generally consider a growth stocks but there has no record on past earnings growth . To convince yourself that you must look at the track record, think about fellow students or colleagues at work. With high probability, you will discover that students who get consistently good grades for a number of semesters continue to get good grades for many more semesters to come. Similarly, people who do well in job continue to do well for many years to come. This correlation also applies to corporations. Companies that have had positive results for a while are likely to exhibit that kind of performance for years to come. An IPO does not provide these track record whether is from sales or earning unless you are very confident about the company itself, it is very hard to perform stock analysis on IPO.

Pricing for IPO

In order to raise capital, there must be a price for the common stocks or shares issues. Here comes the job for an issuer which will determine the price of the IPO. While issuer always try to maximize their issue proceed, there might be chance of underpricing or overpricing. The underpricing of IPOs has constituted a serious anomaly in the literature of financial economics. The effect of “initial underpricing” an IPO is to generate additional interest in the stock when it first becomes publicly traded. Through flipping, this can lead to significant gains for investors who have been allocated shares of the IPO at the offering price. However, underpricing an IPO results in “money left on the table”—lost capital that could have been raised for the company had the stock been offered at a higher price.

Meanwhile the danger of overpricing is also an important consideration. If a stock is offered to the public at a higher price than the market will pay, the underwriters may have trouble meeting their commitments to sell shares. Even if they sell all of the issued shares, if the stock falls in value on the first day of trading, it may lose its marketability and hence even more of its value. It is the responsibility of the issuer to had the pricing correct for its investor.