Initial public offerings can offer investors a number of advantages, including a way to get in early on a company that may yield high returns as investors determine its value in the marketplace. When they are successful, some IPOs can see significant gains in a short time.

On the other hand, some IPOs—including those may be hyped thanks to their well-known brands—can also lose their momentum quickly when the excitement ends. Often with IPOs, a wave of investors might rush to invest in a newly public company, but it might be worth waiting to see what the stock does. Some companies that generated a lot of buzz but then saw shares fall below their listing price without recovering include Fitbit (FIT), GoPro (GPRO), Blue Apron (APRN), and Snap (SNAP).

Try to avoid confusing a company’s popular brand with its business. You may love a particular product, but that doesn’t mean you have to love the stock, too. The financials of a company are ultimately what matters for investors.

If you do jump on a newly public stock, you might want to consider buying shares in partial increments instead of going all in at once.

Finally, investors may want to use caution when considering investing in newly public companies because, in general, these stocks tend to perform well when the overall market does. The overall market has fared well lately, but many investors are on guard for potential downturns.

Initial public offerings (IPOs) often get a lot of press. How well a big-name company does in its market debut can set the tone for trading in similar companies and even in the wider market.

Also, those who are able to buy shares at a company’s initial price have a chance of making a good bit of money. But as with anything stock related, the higher the reward, the higher the risk.

For retail investors who want to try their hand at IPO investing, the truth is that it can be pretty hard to get shares because most of them end up going to institutional investors. Like much else in the economy and stock market, IPO shares allotment boils down to supply and demand. Before taking the plunge, here are some things you may want to consider about how an IPO works, how IPO shares are allotted, and how to buy IPO shares.

In the IPO process, companies going public want to sell as many of their shares as they can at the highest price they can get. So, they hire investment bankers at places like Goldman Sachs (GS), Credit Suisse (CS), or Morgan Stanley (MS) to underwrite the offering and allocate shares to the highest bidders.

There are often multiple underwriters on the same IPO, and this group of investment bankers is called a syndicate. They market IPO shares primarily to institutional investors such as pension funds, hedge funds, or banks.

Slices of Pie

In typical IPOs, about 90% of the shares will go to institutional investors, with about 10% going to retail investors. It’s not that investment banks want to cut out individual investors—it’s just that they’re trying to sell as many shares as possible, and big players have the financial firepower to buy big blocks of shares.

Brokerages that cater to retail investors get portions of the remaining 10% of shares based on their relationship with the underwriting investment bankers. If the brokerage is part of the underwriting team, they may be able to get more shares.

We’re talking about a much smaller piece of the pie that is ultimately going out to the retail investor.

If an IPO is that of a well-known company that investors are keen to buy shares from, it can be difficult for retail investors to get an allocation from their broker’s pile of shares. When there’s more demand for shares than there is supply, an IPO is called oversubscribed. Individual investors have a better chance of getting in on an undersubscribed offering, but the risk is that demand is low for a reason, such as a company not having strong fundamentals.

It comes down to supply and demand and financials’ fundamentals which are not necessarily mutually exclusive.

An IPO or initial public offering is the initial sale of a company stock to the public. Prior to the IPO, the company stock is privately held and cannot be sold to the public. Startup companies may go public to raise money to develop and grow their business. Other companies may go public to expand existing products and services. There are some other advantages to going public. Companies can raise capital without increasing debt and allow existing share holders to profit from company growth by liquidating their shares. On the flip side, companies have increased reporting  requirements, additional marketing, accounting and legal costs. 

So, how exactly does a company go public? For instance, the company gets the help of an investment bank, to underwrite the public offering of the shares. This means they set the price how much each share sells for and in turn the underwriter gets a commission on the sale of these shares. Often the lead underwriter will gather other investment banks into a syndicate allowing more institutions to get involved. The company along with the underwriting syndicate will develop a prospectus, a report detailing the specifics of the offering and will register with the SEC and then get purchase commitments from institutional investors, brokers and other banks. These groups then make shares available generally to high value customers, typically in exchange for holding the stock for a period of time. These placement of shares is the initial public offering. Once the IPO is completed, shares start trading on the stock exchange. It’s here the stock price is determined by the market forces, not the underwriters of the company. Often there is a great deal of excitement in new buying and selling. Investors interested in participating in the initial placement should check with their brokers for share availability. But for the average retail investor buying shares at the offering price before the stocks start trading is difficult. Most will have to wait until it trades in the stock exchange. It is important to realize that the risk of the IPO varies based on the company going public. Some companies have a long history of growth prior to going public, while others are going public to generate money to pay their bills. There are also risks common to most IPOs, including the lack of previous trading history, limited company information and initial price volatility and the risk of loss is substantial. But with the risk of loss comes the potential for profit as well. This potential is one reason many traders pay so much attention to IPOs.

Courtesy: TD Ameritrade