10 Questions to Ask Before Investing in the Next IPO
26 Oct 2017 | Back to Blog
The Jamaica Stock Exchange has been having a few good years. After being named best performing stock market by Bloomberg in 2015, the JSE saw 15 new securities being listed in 2016. Whether the stock market gains brought on the influx of initial public offerings (IPOs) or the other way around, it’s clear that this kind of environment can result in lots of hype as well as an unmistakeable allure. And it can be all too easy to get caught up in the IPO excitement.
As the number of companies going public has quickly increased in recent years, so has the number of opportunities for wealth creation, but not all IPOs are created equal. Now may be as good a time as any to learn how to recognize good opportunities and know what to look for to avoid getting burned.
Here are ten questions you should ask if you’re considering getting in on the next IPO:
Can I get a copy of the prospectus?
Just like any other investment, you should do your homework, and that includes some required reading. The prospectus is the legal document filed with the Financial Services Commission (FSC) that provides details of the offering for sale to the public. It includes details like the number of shares issued, the offering price, company information, associated risks as well as historical financial information and sometimes, projections of the performance into the medium term future. So get out your highlighter, take notes and prepare questions for your broker. That way, information rather than hype, will drive your decisions.
Why are they raising the money?
Companies go public for a variety of reasons. In some cases it’s to raise capital in order to grow the business. In other cases, IPOs are exit strategies for founders and venture capitalists. The prospects for investors are more encouraging if the IPO proceeds are to be used for development, than if the current investors are cashing out. So find out if the current shareholders will be holding on to a significant stake in the company. It means they will have skin in the game, which makes them just as interested in the company’s growth as you will be. Also look into their development plans to find out if they are playing the long game, you want to know whether this stock is an asset you want in your portfolio for the next 5, 10 or 25 years.
Do I understand their products or services?
So you’ve read the prospectus and asked all the ‘whys’, but do you understand what the company does? Investing in an IPO means taking up part ownership of the company, so you should get an understanding of the ins and outs of that company before you say ‘yes’ to the call of the IPO.
Does the management have a good track record?
By now you should understand what and why, but do you know the who? Check out the company’s management. How long have they been a part of the team? Do they have the relevant experience? The prospectus should include information on the company’s management team, and you can learn even more by attending investor briefings. Listen well to get a sense of how conversant and transparent they are about what they’re offering. Pay attention to how precise they are about their plans for the company’s future, and how open they are to your questions and concerns.
What’s the value?
Like anything else you buy, price matters. Current shareholders will want to sell at as high a valuation as possible, buyers into the IPO will want a lower valuation, leaving room for the price to appreciate. The right price is never completely hard and fast. The listing company’s investment bank will do an analysis of the company’s revenue, profits, and the cash generation as well as the debt in their balance sheets. They will also look at the share prices of direct competitors in the same sector. They will then determine the listing price. For a regular investor, valuations can be tough to assess, but you can do your own research into the share prices of similar companies. Look at peer reviews of the valuations given and the price to earnings ratio. And, of course, talk to your Wealth Adviser.
Who is the issuing broker for the IPO?
The issuing broker is the firm that administers the public offering on behalf of the issuer. Look at their track record as well to learn which companies they have taken to market. If the issuing broker is a larger firm that is well known for large, successful IPOs, it is likely they will ensure shares get to reputable, institutional investors, which is usually an indicator of a good deal. Sometimes the issuing broker will underwrite the offering. This means that it will ‘buy’ the shares of the company before they are actually listed on the stock exchange. This underwriter makes its profit on the difference in price between what they paid before the IPO and when the shares are officially offered to the public.
You’ve done your research into all the fundamentals and technicals of the company, great job! But now it’s time to answer some questions about YOU.
Will this investment help with my overall investment strategy?
This is an essential question in the midst of IPO hype. It all looks great, but how does it look in your portfolio. Never forget that investing as all about you and your goals. So before you jump in, have a conversation with your Wealth Adviser about the opportunities the IPO presents for you. Keep the balance of equities and other investments in check, and remember your time horizon!
Do I understand the potential risks?
Earlier we told you to give the prospectus a good read, and that includes the section on risks. Shares in an IPO, like any other stock, are subject to increases and decreases in value, particularly over the short term. So here’s a sub-question: Could you handle your shares losing half their value in year one? That’s what happened after Facebook’s IPO, with the stock plunging to US$17.55 per share from its IPO price of $38 per share. For investors who stuck it out though, five years later Facebook’s share price is now $170.32 a share. IPOs come with both risk and reward; take them on only if you’re prepared for both.
Can I even get shares if I want to?
Ready to get in? First things first, get a broker. Second, find out if your broker has access to the initial offering. Not every broker has access to all IPOs. Third, even if your broker is participating, it can still be a challenge to get new shares. IPOs in Jamaica tend to be highly competitive, and are often oversubscribed. You will need to act quickly and will likely need to meet a certain threshold of investable assets. The Jamaica Stock Exchange (JSE), for its part, has been trying to encourage access to IPOs for the ‘general public.’
What about fees?
As with any other investment, find out the associated fees, assess whether they are fair, and get a good understanding about how they will impact your investment.
Alright. Question time is over. Happy trading!