Factors of an IPO Price
Speculators can experience lucrative returns, as well as substantial losses, with initial public stock offerings (IPOs). Before buying, experts suggest researching the factors used determine the initial price range and then the circumstances that cause the offering to settle at its final price. When researching the investments, analysts also recommend examining the risks associated with the issuing firm’s leadership pool as well as how the firm and its shareholders conduct business.
Several Factors Determine Pricing
Several key components determine IPO prices. These offerings are inherently riskier than regular stock purchases. Speculators should deeply research firms before committing their funds and clearly understand how an enterprise intends to use the raised capital. By investigating company executives, potential stock buyers can try to predict how those leaders will perform in their current positions. The company’s financial history is also a key indicator of future performance.
Complex Dynamics Determine the Initial Price Range
To evaluate an IPO’s initial price range, stakeholders should research the facts that the underwriter – a separate entity that helps firms manage trades – used to set the rate. The underwriter evaluates complex metrics to arrive at the initial price. Investors can learn the criteria used to determine this price by reviewing the preliminary prospectus.
Investors should also consider how much company executives have financially invested in the enterprise and whether there is room for the company to capture more market share. Ideally, the firm will detail these plans in the prospectus. As a loose guide, speculators can also compare the stock value of similar companies to the IPO. A final factor for investors to consider is general stock market performance during the offering.
Investor Sentiment Can Set the Final Price
Other factors can increase or decrease an IPOs final price. Once the issuing firm publishes the preliminary prospectus with the initial IPO price, they will attempt to increase the offering’s value. Firms traditionally promote their IPOs to institutional investment companies and large investors. The underwriter will then use the outcome to determine the IPO final price. If the issuing companies can generate enough interest in the offering, the demand can increase the final price. Conversely, if there is not enough interest, the underwriter will devalue the IPO price.
As a result, investor sentiment – which is not necessarily logic-based – can overly inflate an offering. Because an enterprise hires a star performer to sit on its board of directors does not guarantee that the organization is actually under competent management. These are the types of complex factors that investors must analyze when deciding whether an IPO’s final price is warranted.
Risk Is an Important Factor
It is also important to valuate a company’s risk profile. Firms publish this information in the prospectus risk factor section. Experts strongly caution potential investors to balance risk and earnings potential when considering a buy in. Political instability at a firm’s primary locale can signal trouble in the near future, and lack of supplier diversity can cause production problems. Legislators require each firm issuing an initial public offering to include a detailed risk factor disclosure in their prospectus. Extensive financial obligations and costly, time-consuming litigation can indicate future trouble for a firm and its IPO stock.
Some experts suggest observing how a company’s stock performs once the excitement over the initial IPO announcement subsides. This can prevent investors from waiting indefinitely to break even if the stock devalues quickly.
Leadership Can Also Make a Difference
Potential IPO buyers should know who runs the company behind the offering. Executive biographies can provide an accurate performance indicator. If an executive’s former company filed for bankruptcy, there is a good chance that the individual is not fiscally adept. Additionally, executive legal histories can suggest potential pitfalls such as whether the company heads follow compliance guidelines. Investors should also research a company’s majority shareholders to gain insight into the firm’s corporate culture and ethics.
Overall, Risk Is the Determining Factor
Failure to actively review and refine corporate governance is an increased investment risk. An incompetent board of directors can fail to manage company controls, which then do not suit current operations. Additionally, if a firm does not indicate corporate governance policies in the prospectus, this can indicate subversion and, in effect, a high-risk investment. Another warning sign is if a firm underrepresents its minority shareholders.
Corporate governance is critical for several reasons. Proper controls make it easier to obtain needed funding and reduces the cost of borrowing. It also improves an organization’s status and increases a firm’s standard operating efficiency. Most importantly, enterprises that practice appropriate corporate governance are more attentive to shareholder concerns.
Investors can win or lose big with an initial public offering. Consequently, financial experts recommend exercising due diligence before committing funds to an IPO. To do this, speculators can determine an IPO’s initial price range by reviewing the preliminary prospectus and then using that information to make sure that the underwriter’s final appraisal accurately represents the offering’s worth. Leadership traits as well as a company’s ownership culture can also help investors identify winners and mitigate risks.
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http://www.ifc.org/wps/wcm/connect/topics_ext_content/ifc_external_corporate_site/corporate+governance/investments/methodology. Accessed July 31, 2016