What Is a Hot IPO?

The term hot IPO refers to an initial public offering with significant demand.

These IPOs are popular, drawing a tremendous amount of interest from investors and the media even before they hit the market. This hype and attention generally lead to a significant rise in share prices after the company goes public.

Hot IPOs may be risky, especially when it comes to investing in companies that don't have a proven track record of success.

Key Takeaways

  • A hot IPO is an initial public offering that garners great interest from the media and demand from investors.
  • Higher demand leads to sharp price increases in the secondary market, which are generally not sustainable.
  • Companies bring in at least one bank to underwrite and handle the pricing, marketing, and decisions about the number of shares and share price range.
  • The demand for shares in a hot IPO surpasses the initial supply, which means the price needs to be revised upward.
  • Underpriced hot IPOs will likely see their stock price rise after the shares begin trading while the stock price drops for overpriced ones,

How Hot IPOs Work

Private companies that want to go public often do so by issuing stock through an initial public offering. They can raise a substantial amount of money in a short time, particularly if the issuance attracts public attention and becomes a hot IPO. An IPO gives a private company a chance to cash in on the public’s demand for its shares.

The first step is for the company to find at least one investment bank to act as an underwriter. The underwriter(s) markets the IPO, helping the company set a per-share price. Banks assume a specific number of shares, which they will offer to their buyers, who are either institutional or retail investors. The banks collect a portion of the sale proceeds as a fee, which is called the underwriting spread.

IPOs are considered hot if and when they draw a great deal of attention from the media, which can lead to a lot of interest from investors. By going through the hot IPO process, companies can raise a lot of capital in a short amount of time. This allows them to pay off their debts, fund their operations, and set aside money for future growth.

The increased demand for shares in a hot IPO often leads to a sharp rise in the price of the stock soon after it begins trading. This sudden increase in share price is often not sustainable, which means the price drops. This pattern can have a big impact on the market itself.

Sharp price moves can affect initial shareholders after trading opens on the secondary market. Underwriters may give preferential treatment to high-value clients when offering shares in a hot IPO, so they bear some risk if they overprice the stock. 

A hot IPO is not a guaranteed win for investors because the hype doesn't bear the planned fruit for the investor.

Special Considerations

Hot IPOs appeal to investors who anticipate that the demand for shares will outstrip the number of shares offered. IPOs with more demand than supply are considered oversubscribed, making them a target for short-term speculators as well as those who see a long-term opportunity in holding the equity.

Because a hot IPO is likely to be oversubscribed, companies often allow their underwriters to increase the size of the offering to accommodate more investors and make more money.

Underwriters must balance the size of the IPO with the appropriate price for the level of interest in the offering. When done correctly, this balancing will maximize profit for the company and its underwriter banks.

If a hot IPO is an underpriced issue, it will usually see a rapid rise in price after the shares hit the market and the market adjusts to the high demand for the stock. Overpricing the IPO can lead to a rapid fall in prices, even though the higher price benefits the underwriting bank issuing the stock since it only makes money on the initial issue.

Companies have other ways they can go public, including a direct listing or a direct public offering.

Examples of a Hot IPO

Social giant Facebook's initial public offering is commonly considered a hot IPO. In early 2012, analysts indicated that its long-awaited IPO, seeking to raise about $10.6 billion by selling more than 337 million shares at $28 to $35 per share, could generate such significant interest from investors.

Those analysts predicted an oversubscribed IPO.

When the market opened on May 18, 2012, investor interest showed a higher demand for the company's shares than it offered. To take advantage of the oversubscribed IPO and fulfill investor demand, Facebook increased the number of shares to 421 million. But it also raised the price range to $34 to $38 per share.

Facebook and its underwriters effectively raised both the supply and price of shares to meet demand, diminishing their oversubscription.

However, it quickly became clear that Facebook was not oversubscribed at its IPO price, as the stock fell precipitously in its first four months of trading. The stock failed to trade above its IPO price until July 31, 2013.