Should You Invest In An IPO?

(As always, the examples here are specific to the Philippines but the overall lesson can be applied to any stock market).

If you’ve been following up on investing news, then you’ve probably heard of the term IPO at least once. You might even see it in social media, and you’ll even find that most people get very excited at the prospect of a company that they know is going IPO.

But what is an IPO? Why do companies do IPOs? And more importantly, should you buy shares on an IPO?

This article will answer those questions for you. Let’s start by learning about the IPO basics.

What is an IPO?

An Initial Public Offering (or IPO) is the first time that a company makes some of its shares (at least 20%) available to be purchased by the public. This means that regular people like you and me can now be owners of that company if we participate in the IPO and buy their shares.

Shakey’s Pizza, with the ticker PIZZA, had its IPO on December 2016. This means that before that date, you and me and other regular people cannot own PIZZA’s shares. However, starting sometime December 2016 when they did their IPO, we can now start buying and owning their shares if we want to.

(if you don’t know what a “ticker” is, then check out this article on stock market terms.)

Essentially, every single stock available in the stock market has done their IPO sometime before.

Why Would Businesses Go IPO?

Technically, there are 2 kinds of shares a company can sell at an IPO. It can either be existing shares held by the current owners or new shares made specifically for the IPO. (And they can also do a combination of selling both).

If the IPO is selling the existing shares of the current shareholders, then the shareholders get the money from the IPO. In other words, you are buying the shares from the current owners and the money goes to them and not to the business.

If that is the case, nothing really changes in the company financially.

The other situation is when new shares are made specifically for the IPO and those are sold to the public. Here, the company receives the money and they can use it for many purposes, but usually it will be for:

  • Generally making the company better (funding research, development, etc)
  • Expanding the company (funding new products, new locations, buying other businesses, etc)
  • Paying the existing debts of the company

In any case though, they will want to set their IPO prices as high as they can since they are selling their shares and they want as much cash for a single share. Of course, they have to strike a balance there since if it’s too high, nobody might buy the shares.

Continuing our PIZZA example, they sold their shares at P11.26 per share when they did their IPO.

Now let’s discuss the more important question…

Should You Invest In An IPO?

The short answer is no.

The long answer is nooooooooooo.

All kidding aside though, while there are a few pros when it comes to investing in an IPO, there are even bigger AND heavier cons. Let’s talk about them.

IPO Con #1: It’s Difficult To Determine If It Is A Good Company

Obviously, you will want to invest in companies that are earning and doing well (large businesses, with many customers, good products, etc.). I mean, who would want to invest in loser companies, right?

However, when a company will go IPO, there will be only a few reports that you can look at to determine as to whether they are doing well or doing poorly.

Their reports will probably only cover their performance over the last year or two, which will not be enough basis for you to make a solid decision.

Essentially, you should be investing in well performing companies and if you can’t determine if they are performing well, then you should skip them. Hence, skip IPOs.

IPO Con #2: The Price Is Expensive

If you’ve been following our guides, or reading investing books, then you know that the price of the stock makes or breaks it as an investment. If the stock price is too high, then good businesses become bad investments.

Now, remember how IPOs are basically the company selling their shares? If people like the thing you are selling, would you sell them at a lower or higher price? (Obviously sell at a higher price!)

In other words, companies will definitely set a high price for their stock during IPOs. This makes IPOs bad investments as they are too expensive to properly profit from.

It would be best for you to buy other stocks already on the stock market that are currently cheap, rather than the shiny, new IPO stock that is very expensive.

PIZZA for example, had an IPO price of P11.26 but we believe it should only be worth around P6 to be an attractive investment. Definitely overpriced!

IPO Con #3: IPOs Are Overhyped and You Have FOMO

You see other people talk about the IPO and how excited they are at possibly buying the new stock. You feel excited too!

And then there is FOMO, which means the Fear Of Missing Out. You see others do it, especially your friends and family, and you feel fearful that you’ll miss out on a great opportunity that others are availing!

And what’s worse is that you’re probably not even aware that this is what’s happening to you!

This is extremely dangerous because you are now making investing decisions using your emotions, which is just plain wrong! Investment decisions must be made by thinking about the facts, and not because of your feelings.

So, make sure you’re not buying a stock because of hype!

IPO Con #4: It's Probably A Bad Company To Begin With

Just because a company is doing an IPO or is already selling their stocks in the stock market, that doesn’t mean they are good companies or good investments.

Of the almost 300 companies in the PSE, there are probably only less than 100 that we would consider as good to excellent stocks for investments. That’s a lot of terrible companies!

This is most especially true if the company doing an IPO is a small company you are not familiar with.

IPO Con #5: Some Companies Go IPO To Get Rid Of Debt

Most of the time, companies will IPO to get money so that they can expand their business, which is great for them and their shareholders.

However, sometimes companies do IPOs so that the money they raise can be used to pay off their liabilities, which is awful. This means that even if the company is able to amass huge amounts of cash from their IPO, they won’t be able to expand or become better since the money is used to pay for debt!

Terrible! Definitely avoid IPOs like that at all cost.

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"What Should I Do With An IPO Then?"

I suggest you do what we would do on an IPO, which is to just ignore it. Just forget there are even IPOs and ignore any news of it.

I mean, there are sooo many stocks already on the stock market. Chances are, there are current stocks on the market that are probably better businesses than the company doing the IPO.

Also, chances are that the companies already on the stock market have cheaper prices.

We know IPOs are exciting and they seem like fun. However, you’re not here to have fun and be excited, that’s what casinos are for! Instead, you’re here to make money and IPOs are not a good option for that.

So, ignore IPOs and just concentrate on investing in companies already on the market.

“But I Did My Research And Analysis And Concluded I SHOULD BUY!”

Alright, let’s say that you are knowledgeable and skilled enough to do your own research and analysis on an IPO stock and you determined it would be an okay or maybe even a great investment. Should you buy it?

Well, although extremely rare, we will admit that there are likely going to be IPOs that would be okay to buy… maybe. So, if you’re sure about what you’re doing then by all means buy, in the IPO.

But again, make sure you absolutely know exactly what you’re doing. And if you’re not sure about what you’re doing, then just skip the IPO.

There Are stocks That Go Up After Their IPO

Alright, that’s actually true. There are some stocks that rise up after they do an IPO.

Of course, they also drop back down after a year or two. Sometimes they drop so low to a price less than their IPO price.

If you’re planning to buy in an IPO to anticipate the rising stock price right after, and sell in a few months or so, then you can probably get some “okay” gains… maybe.

But it’s also risky as it might also go down immediately after an IPO and you lose money.

In any case, you’re thinking like a trader, which is not what this blog is about. We teach true investing and do not mix our principles with trading principles. Trading is just too risky, so we don’t practice it.

Summary:

  • IPOs are the first time a company sells their shares to the stock market
  • Money raised in the IPO can be used to expand the business, or pay debts, or pay existing shareholders
  • There are multiple reasons why investing in IPOs are not a good idea
  • There are IPOs that can be good investments, but they will be rare (make sure you know what you’re doing if you invest in them!)

And that’s it!

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Good luck we hope you learned something!

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