A:

The price of a financial asset traded on the market is set by the forces of supply and demand. Newly issued stocks are no exception to this rule - they sell for whatever price a person is willing to pay for them. The best analysts are experts at evaluating stocks. They figure out what a stock is worth, and if the stock is trading at a discount from what they believe it is worth, they will buy the stock and hold it until they can sell it for a price that is close to, or above, what they believe is a fair price for the stock. Conversely, if a good analyst finds a stock trading for more than he or she believes it is worth, he or she moves on to analyzing another company, or short sells the overpriced stock, anticipating a market correction in the share price.

Initial public offerings (IPOs) are unique stocks because they are newly issued. The companies that issue IPOs have not been traded previously on an exchange and are less thoroughly analyzed than those companies that have been traded for a long time. Some people believe that the lack of historical share price performance provides a buying opportunity, while others think that because IPOs have not yet been analyzed and scrutinized by the market, they are considerably riskier than stocks that have a history of being analyzed. A number of methods can be used to analyze IPOs, but because these stocks don't have a demonstrated past performance, analyzing them using conventional means becomes a bit trickier. (For more information, check out our IPO Tutorial and The Murky Waters Of The IPO Market.)

If you're lucky enough to have a good relationship with your broker, you may be able to purchase oversubscribed new issues before other clients. These tend to appreciate considerably in price as soon as they become available on the market: because demand for these issues is higher than supply, the price of oversubscribed IPOs tends to increase until supply and demand come into equilibrium. If you're an investor who doesn't get the first right to buy new issues, there's still an opportunity to make money, but it involves doing a substantial amount of work analyzing the issuing companies. Here are some points that should be evaluated when looking at a new issue:

1. Why has the company elected to go public?
2. What will the company be doing with the money raised in the IPO?
3. What is the competitive landscape in the market for the business's products or services? What is the company's position in this landscape?
4. What are the company's growth prospects?
5. What level of profitability does the company expect to achieve?
6. What is the management like? Do the people involved have previous experience running a publicly-traded company? Do they have a history of success in business ventures? Do they have sufficient business experience and qualifications to run the company? Does management itself own any shares in the business?
7. What is the business's operating history, if any?

This information and more should be found in the company's S-1 statement, which is required reading for an IPO analyst. After reading the company's S-1, you should have a pretty good understanding of the characteristics of the business and the operations at the company. Given these characteristics, find out what you believe to be a reasonable valuation for the company. Divide this number by the number of shares on offer to find out what's a reasonable price for the stock. Other valuation strategies could include comparing the new issue to similar companies that are already listed on an exchange to determine whether or not the IPO price is justified.

RELATED FAQS
  1. How can average investors get involved in an IPO?

    An initial public offering, or IPO, is the first sale of stock by a new company, usually a private company trying to go public. ... Read Answer >>
  2. What are the different types of IPO issued?

    Learn about the two ways for a company to go public: fixed price and book building. Under fixed price, the share price is ... Read Answer >>
  3. Are IPOs available to short sell immediately upon trading, or is there a time limit ...

    The quick answer to this question is that an IPO can be shorted upon initial trading, but it is not an easy thing to do at ... Read Answer >>
  4. Can mutual funds invest in IPOs?

    Learn whether mutual funds can invest in IPOs. IPO investing is appealing because there is a big upside, but there is considerable ... Read Answer >>
  5. What does 'going public' mean?

    Going public refers to a private company's initial public offering (IPO), thus becoming a publicly traded and owned entity. ... Read Answer >>
  6. What is the difference between an IPO and a seasoned issue?

    Learn how companies issue IPO securities when they first go public and seasoned issue shares if they sell more shares in ... Read Answer >>
Related Articles
  1. Investing

    How An IPO Is Valued

    The initial valuation of an IPO can determine the success or failure of a specific stock - but how is that price determined?
  2. Investing

    How The Stock Market Works

    When you buy a stock, you buy a piece of a company.
  3. Investing

    Market Volatility, Weak Economy Delay Major IPOs

    These outside factors can delay and affect IPOs when they are finally listed on a stock exchange.
  4. Insights

    Why Are Companies Taking Longer To Go Public?

    Learn why private companies are waiting longer to have their IPOs. Understand why it may be more advantageous for a company to stay private.
  5. Investing

    Why Do Companies Care About Their Stock Prices?

    Read on to learn more about the nature of stocks and the true meaning of ownership.
  6. Insights

    A Breakdown on How the Stock Market Works

    Learn what it means to own stocks and shares, why shares exist, and how you buy and sell them.
  7. Insurance

    How An IPO Is Valued

    The process of determining a company’s initial share price includes quantitative and qualitative components.
  8. Financial Advisor

    Advising FAs: How To Explaining Stocks to a Client

    Without a doubt, common stocks are one of the greatest tools ever invented for building wealth.
  9. Insurance

    IPOs For Beginners

    IPO is one of the few market acronyms that almost everyone is familiar with. Discover if IPOS are worth all the attention.
RELATED TERMS
  1. Hot Issue

    An issue that sells at a premium over the public offering price ...
  2. Hot IPO

    An initial public offering that appeals to many investors and ...
  3. Break Issue

    A type of stock initial public offering (IPO) that trades below ...
  4. Oversubscribed

    A situation in which the demand for an initial public offering ...
  5. Offering

    The issue or sale of a security by a company. It is often used ...
  6. Initial Public Offering - IPO

    The first sale of stock by a private company to the public. IPOs ...
Hot Definitions
  1. Redlining

    The unethical practice whereby financial institutions make it extremely difficult or impossible for residents of poor inner-city ...
  2. Nonfarm Payroll

    A statistic researched, recorded and reported by the U.S. Bureau of Labor Statistics intended to represent the total number ...
  3. Conflict Theory

    A theory propounded by Karl Marx that claims society is in a state of perpetual conflict due to competition for limited resources. ...
  4. Inflation-Linked Savings Bonds (I Bonds)

    U.S. government-issued debt securities similar to regular savings bonds, except they offer an investor inflationary protection, ...
  5. Peak Globalization

    Peak globalization is a theoretical point at which the trend towards more integrated world economies reverses or halts.
  6. Phishing

    A method of identity theft carried out through the creation of a website that seems to represent a legitimate company. The ...
Trading Center