How to Invest in IPOs: 7 Steps to Buy New Shares in 2024

Do you find the idea of investing in IPOs and becoming an early investor when shares of a company first become available to the public appealing?

IPO investments often stand out as some of the biggest successes and failures. The large stock price swings on the first days of trading create the first set of winners and losers.

For those that hold on, buying IPOs from the likes of Apple (AAPL), Microsoft (MSFT), or Warren Buffett’s Berkshire Hathaway (BRK) has created some of the most impressive returns in history.

Key Takeaways

  • IPOs offer unique investment opportunities but come with inherent risks and potential for high volatility, especially in their early trading days.
  • Proper research and understanding of a company’s business model, financial health, and market position using its prospectus are crucial before investing in its IPO.
  • Early access to IPO investments typically requires an account with a brokerage that offers IPO shares allocations. Most people buy shares once they open on the stock exchange.
  • The choice between an IPO and a DPO can affect the early price discovery process, though it does not determine the long-term value of the company’s shares.

Participating in an Initial Public Offering (IPO)

An initial public offering (IPO) marks the first time a company offers its shares to the public, commonly employed by newer companies seeking funds for growth.

In this process, shares are first sold in the primary market at a price set by the leading underwriter, who coordinates with a group of investment banks and brokerage firms who agree to receive allocations of shares that they will distribute to their clients.

If you qualify, you can receive an allocation of shares from your broker, or once they begin trading on the stock exchange.

How to invest in IPOs: A Step-By-Step Guide

1) Make a Shortlist of IPO Candidates

There’s nothing worse than hearing about a great company going public after the fact!

Investors interested in how to invest in IPOs need to stay informed about the market to spot new stocks making their debut. This involves monitoring financial news platforms and exchanges where these new stocks are listed. You can also check IPO calendars or ask to be included on your broker’s mailing list for future IPOs if they have one.

Reading about upcoming IPOs, like a hypothetical “how to buy Reddit IPO” article, can provide insights into specific companies and market sentiment. However, it is crucial to go beyond surface-level information and prepare to delve into detailed research once these companies file their offering documents.

It is beneficial to focus on sectors and businesses you understand, as well as those showing robust growth prospects. For instance, technology or healthcare sectors often attract significant investor interest due to their potential for innovation and expansion.

IPO investment requires a proactive approach. Keep an eye on announcements from well-known private companies and, if possible, attend IPO roadshows that can offer early insights into a company’s plans and market expectations.

2) Read the Prospectuses of Offerings

A prospectus is a formal legal document required by and filed with the Securities and Exchange Commission (SEC) that provides details about an investment offering for sale to the public.

For IPO stocks, the prospectus offers a wealth of information that is vital for making informed investment decisions.

Page from the Reddit Prospectus
Page from the Reddit Prospectus. Source: Reddit, SEC

The prospectus contains critical data about the company’s business model, financials, leadership, competitive landscape, and the risks associated with the investment.

It goes without saying that a company going public has no documented history of earnings as a public company. That makes it essential to read and understand the prospectus thoroughly since it’s really the only resource for evaluating the company’s potential for growth, not to mention how the new stock might align (or not) with your investment objectives.

To save time, you can focus on certain sections within the prospectus, including:

  • The company’s financial statements
  • Management’s discussion
  • Analysis (MD&A)
  • Risk factors
  • Use of proceeds

By scrutinizing these sections, you gain a deeper understanding of the company’s financial health, strategic direction, and the potential challenges it may face.

In the context of IPO investing, it’s also helpful to compare the information in the prospectus with industry benchmarks and competitors.

This analysis can shed light on the company’s market position and growth prospects relative to the companies already out there competing in the marketplace.

3) Analyze the Registration Statement

Regulators of most global stock markets require a business looking to list on the stock exchange to file a registration statement, which in the US is referred to as Form S-1.

This document, filed with the Securities and Exchange Commission (SEC), provides a detailed look at the company’s financials, business operations, and the risks involved in the IPO investment.

FYI, the prospectus is part of the S-1 and can be considered a more user-friendly extract from the S-1, which makes for a better first reading before you dig in deeper.

4) Check Your Eligibility to Participate in IPOs

This step basically involves you asking your brokerage if they have been given an allocation of IPO shares and asking if you can participate.

It is through either your investment bank or brokerage account that you can acquire shares at the set offering price, known as “participating in the IPO.” This participation occurs prior to the stock being available for trading on the stock exchanges.

Most brokerages have pre-qualifying criteria for you to meet to participate, including minimum net worth and market experience levels.

Most investors don’t qualify to participate in the IPO, or even if they do, don’t receive an allocation because large institutions or HNW individuals have more sway to get first in line.

Fortunately, with the growing trend of democratizing investment opportunities, more platforms now facilitate retail investor access to IPO investing, albeit still subject to eligibility checks.

5) Make a Strategy for When to Buy and Sell

How to buy IPO stock should be rooted in a solid stock trading strategy with strict rules on acceptable prices to buy and sell.

When to Buy IPO Stocks

Deciding the right time to buy IPO stocks can be challenging. Ideally, you want to purchase at the offering price before the stock begins trading on the open market. However, the next best thing is to buy shares after they start trading.

Given the extra excitement of a new listing as well as higher trading volumes, volatility can be high so it’s important to decide beforehand a price range that you’re comfortable with for buying. It’s always a good idea to run through some likely scenarios in your head and what your course of action will be.

Example

If the shares drop 10% on the opening day of trading, I’ll:

  1. Snap them up at a discount, or
  2. Stay away until the price stabilizes.

You have the choice to buy in when there is lots of action in the first two days or wait for a lull in activity before stepping in.

Analysis from ResearchGate shows the average daily trading volume after an IPO.

A chart showing the pattern of IPO trading volume for the first 20 days after listing

When to Sell IPO Stocks

Deciding when to sell is equally important. Some investors look for short-term gains, planning to sell shortly after the stock price appreciates post-IPO.

Others may see more value in holding onto their shares for the long term, believing in the company’s potential for sustained growth.

It’s crucial to set predetermined criteria for selling, which might include achieving a certain return percentage or when there are changes in the company’s fundamentals.

Risk Management

Regardless of the specific buy-and-sell strategy, risk management should be a cornerstone of your approach. This includes setting stop-loss orders to limit potential losses and regularly reviewing your investment thesis in light of new information and market trends.

6) Wait for Allocation and for Trading to Start

Allocation Process

In the case of an IPO, not every investor who expresses interest will receive shares during the allocation process.

Allocation is often influenced by factors such as the amount of interest in the IPO, your relationship with the brokerage, and the size of your investment.

If you are allocated shares, your brokerage will notify you about the number of shares you’ve received before they begin trading publicly.

Trading Commencement

If you do not receive an allocation or choose to buy after the IPO, your next opportunity for buying IPO stocks is when they begin trading on the open market.

The opening price can be significantly different from the IPO price based on early demand and supply dynamics.

Monitoring the stock’s initial trading activity can provide insights into market sentiment and potential price volatility.

7) Buy in and Monitor Your Position

Executing Your Purchase

If you’ve been allocated your shares, there’s nothing really to do here. If you happen to be a company insider, then you’ll likely have a lock-up period of several months before you can sell.

As a public investor, you can usually sell your shares as soon as you like.

For those buying IPO stocks on the open market, it is crucial to execute your purchase according to your strategy. Market conditions can change rapidly, especially during an IPO’s early trading days, so responsiveness and attention to detail are key.

Monitoring Your Investment

Once you own the shares, the work of monitoring your investment begins. This involves tracking the stock’s performance, staying updated on company news, and understanding market trends that could affect the stock’s value.

Benefits and Pitfalls of investing in IPO stocks

Benefits of Investing in IPO Stocks

  • Early access provides an opportunity to purchase shares at the offering price, potentially lower than future market prices.
  • Companies typically go public to raise funds for growth initiatives, which, if successful, could increase the stock’s value.
  • A well-received IPO can benefit from strong market interest, potentially yielding quick gains.

Pitfalls of Investing in IPO Stocks

  • IPO stocks can exhibit significant price swings shortly after listing, which might lead to losses.
  • IPOs lack extensive market performance history, making them harder to evaluate.
  • The end of lock-up periods can trigger market volatility as insiders start selling off their shares.
  • Intense excitement around an IPO can lead to an inflated valuation, resulting in a possible correction and losses thereafter.

IPO Investing Examples

After a slow period for IPO investments, things appear to be heating up in 2024 after the successful IPO of Reddit, a social media company that captured the public’s imagination.

Example 1: Reddit

Reddit shares boomed across the first four days of trading in March 2024, rising as high as $65 during the first days of trading after an IPO opening price of $47.

Reddit managed to capture the imagination of the public owing to its prominent position in public life as a social media platform as well as its new foray into data-licensing to AI firms, potentially a big new money spinner in the hottest new field.

The shares dropped 11% on the 5th day after the introduction of options trading, where investors could buy put options to speculate on a decline in the share price.

A chart showing Reddit's stock performance during the first days of trading
Reddit (RDDT) stock performance during the first days of trading. Source: Investing.com

Example 2: Uber

The Uber IPO, which was highly anticipated in 2019, saw a disappointing debut, with its share price dropping in the initial days of trading.

Although briefly making new post-IPO highs, the company’s shares did not show significant upward momentum until three years later.

This lag in performance could be attributed to various factors, including market conditions, investor sentiment towards tech IPOs, and Uber’s financial and operational challenges during that period.

A chart showing Uber's stock performance three years after the IPO.
Uber (UBER) stock performance three years after the IPO. Source: Investing.com

IPO vs. DPO

An initial public offering (IPO) and a direct public offering (DPO) are two distinct methods through which a company can go public and offer its shares to the public.

In an IPO, the company typically works with investment banks to underwrite the offering, set the initial price, and sell the shares to investors. This process can be costly and time-consuming but helps establish market demand and valuation for the company’s shares.

Conversely, a DPO allows the company to directly sell its shares to the public without intermediaries, reducing underwriting fees and providing more control over the pricing and timing of the sale.

While DPOs can be less expensive and more straightforward, they may not provide the same level of exposure or capital as an IPO, potentially limiting the initial demand and liquidity for the shares.

Ultimately, while the listing type – be it an IPO or a DPO – can influence the initial market perception and price discovery process during the early trading days, it should not dictate the long-term value of the shares.

Over time, the intrinsic value of a company reflected through its financial performance, growth prospects, and market conditions plays a more crucial role in determining its stock value than the method through which it went public.

The Bottom Line: Should I Invest in IPOs?

Investing in IPOs should align with your investment strategy and risk tolerance.

While IPOs can offer growth potential, they also come with volatility and uncertainty, especially in early trading days. Thorough research and understanding of the company’s fundamentals are crucial before making an investment decision in IPOs.

Do your own research and always remember your investment decision depends on your attitude to risk, your expertise in the stock market, the spread of your portfolio, and how comfortable you feel about losing money.

The information in this guide does not constitute investment advice and is meant for informational purposes only.

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Jasper Lawler
Financial expert

Jasper cut his teeth on Wall Street as a stockbroker and honed his analytical skills with the City of London's top trading firms. Today, he applies his financial expertise to content creation as the founder of Trading Writers, a niche content marketing agency for the finance sector. Jasper's articles can be found on Techopedia, Seeking Alpha, UK Investor Magazine, Trade2win, Investing.com, FXStreet, Trading212.com, FlowBank.com, and Capital.com. His analysis has been quoted in prestigious publications such as the Financial Times, Bloomberg, Reuters, AFP, and City AM. Jasper's transition from stockbroker to content creator highlights his deep understanding of the financial markets…