When a private company offers purchasable stock shares to the public, it then becomes a public company. This process is called initial public offering (IPO). The company would register in the U.S. Securities and Exchange Commission and then usually become a part of one of the significant exchanges (like NASDAQ). Investors can now have access to purchasing these new stocks.
The Point of an IPO:
A company usually starts this process when they seek to raise their capital and garner an economic boost to help them in their ventures. Overall, it is usually very beneficial for the company’s side, given that people do decide to invest. However, to be public, the company is obligated to release disclosure statements and financial situations regularly. Any data that expresses even an indication of a poor financial state can be off-putting to investors and thus limit any profit.
Since an IPO is a company’s first time selling shares, these shares usually are targeted to be sold at a lower price. Sometimes, the IPO starting stock price can be very high and unappealing to potential investors. In this case, stock splits may be offered, in which individual shares are split/divided to lower the price. For example, a starting share price of $200 can be split into 10 shares worth $20 each. Since this new stock price would correlate to the new number of shares, investors who have owned the stock before the split do not experience a change in value, and neither does the company's market capitalization. Many new investors may be inclined to buy the stock after the split due to the lower price.
IPO stocks can be risky for the investor; there is no guarantee of profit. If the company ends up being successful, buying low and early is one of the best things to do considering the profit that can be obtained once the stock goes up. However, it is not common for companies to obtain great success. Oftentimes, IPO stocks will underperform and do not live up to their expectations. Such stocks are also usually volatile, and fluctuate often, which makes it hard to gauge any indication of potential success. The only predictions that investors can make is based on thorough research of the company's financial standing, business model, data, competition, etc. Thus, it should be reiterated that IPO stocks are highly risky.
Sometimes, IPO stocks offer what is known as dividends. In other words, regular payment to owners of a stock during a period. Companies with consistent earnings and a trend of profit may pay these dividends to “reward” their shareholders. This can be attractive to investors who would like to obtain a structured income. If an IPO stock becomes successful, the dividend payout can increase substantially given time, and can even exceed the initial investment after years.
Overall, the IPO process is something that investors should be wary of. Despite coming with great rewards, it also comes with great risks. Inexperience can undoubtedly lead to more harm than gain, so starters should steer clear and prioritize secure, long-term investments. However, it is good to know this information, which are staple terms in the business world. Perhaps you’ll decide to invest in a promising IPO stock later on in the future and benefit significantly from it-- who knows! Just remember to do your research!
Written by Brian Caballo