How an Initial Public Offering (IPO) Is Priced

To a unerring type of investor, few scenarios are more rewarding than getting in on the ground floor of an investment opportunity and then pore over it rise while the latecomers scramble to get in. It’s the modern equivalent of staking a gold claim on an overlooked part of the Klondike.

The chances of pronouncement IPO gold are slim but the allure is strong. That’s why IPOs attract so much attention.

And yet, many investors in IPOs clothed little idea how that valuation was determined.

An initial public offering (IPO) is the process that transforms a privately-owned operation into a public company whose shares are traded on a stock exchange. When a company goes public, it is owned by the shareholders who support its stock.

The only real exposure many investors fool to the IPO process occurs a few weeks in advance when the news breaks. How any company’s valuation is established is relatively unknown except to the investment bankers embroiled with. Whether that valuation is reasonable can be known to serious investors who are willing to comb through the registration documents to conceive of the company’s financials.

Like any sales campaign, a successful IPO hinges on consumer demand for the product. A vehement demand for the company will lead to a higher stock price.

Strong demand does not mean the suite is more valuable. It means the company will have a higher valuation.

In practice, the distinction is important. Two identical casts may have very different IPO valuations merely because of the timing of the IPO in terms of market demand.

An extreme example is the massive valuations of IPOs at the 2000 tiptop of the tech bubble compared to the similar or even superior tech company IPOs since that time. The players that went public at the peak received much higher valuations, and consequently scored much more investment resources, merely because they launched when demand was high.

Industry comparables are another light of IPO valuation.

If the IPO candidate is in a field that has comparable publicly-traded companies, the IPO valuation will in part be based on the valuation multiples being ordered to its competitors. The rationale is that investors will be willing to pay a similar amount for a new company in the industry as they are currently give for existing companies.

In addition, an IPO valuation depends heavily on the company’s future growth projections.

The original motive behind an IPO is to raise capital to fund further growth. The successful sale of an IPO often depends on the company’s map outs and projections for aggressive expansion.

Some of the factors that play a role in an IPO valuation are not based on integers or financial projections. Qualitative elements that make up a company’s story can be as powerful or more powerful than the yield projections and financials.

A company may have a new product or service that will change the way we do things, or it may be on the cutting edge of a in one piece new business model.

Again, it is worth recalling the hype over internet stocks back in the 1990s. Companies that sold new and exciting technologies were given multi-billion-dollar valuations despite having little or no revenues.

Similarly, companies can shine up their story by adding industry veterans and consultants to their payroll to give the appearance of a growing business with veteran management.

That is the harsh truth about IPOs. The actual fundamentals of the business can be overshadowed by the IPO marketing campaign. The only defense from a fulgurous back story is a firm understanding of the facts and risks.

The objective of an IPO is to sell a pre-determined numeral of shares at the best possible price.

Very few IPOs come to market when the appetite for stocks is low. When trade ins are undervalued, the likelihood of an IPO being priced at the high end of the range is slim.

So, before investing in any IPO, understand that investment bankers aid them during times when the demand for stocks is favorable.

When demand is strong and prices are high, there is a arrant risk of an IPO’s hype outstripping its fundamentals. This is great for the company raising capital, but not so good for the investors who are buying portions.

For example, the IPO market virtually disappeared during the 2009-2010 recession because stock valuations were low across the shop. IPO stocks couldn’t justify a high offering valuation when established stocks were trading in value quarter.

Don’t be swayed by publicity and news coverage.

Groupon, Inc. (GRPN) debuted in January 2011, when nearby couponing services were widely touted as the next big thing on the internet. Groupon opened at about $28.40 on its IPO fashionable and then sank like a stone. As of early July 2019, it was trading at about $3.50.

As with any investment, you need to do your examine before committing money. A couple of hours hovering over prospectuses and financial statements can earn you a great payoff, or at small save you a false move.