Navigating the Realities of Investing in IPOs: Debunking Myths and Assessing Opportunities

Is investing in an initial public offering (IPO) a wise move? It's not as straightforward as it may seem. While media attention and high valuations create hype around IPOs, they don't always guarantee a favorable investment. Investing in IPOs is better suited for long-term investors willing to hold shares, as these newly public companies often lack a proven track record.

Individual investors have the option to purchase IPO stock directly through a brokerage account or by investing in small-/mid-cap growth mutual funds. However, there are several misconceptions surrounding IPO investments that need to be addressed before diving in.

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One common myth is that investing in an IPO is a good idea simply because the public is excited about it. However, extreme valuations can indicate unfavorable risk and reward at current price levels. Additionally, the lack of a proven track record and the competitive landscape can impact the performance of an IPO, making it a risky decision.

Another misconception is that IPO investments yield higher rewards compared to waiting to invest. In reality, the financial results from IPO investments are mixed, with both successful and failed IPOs. Although predicted growth attracts attention and leads to higher valuations, these valuations can become problematic during economic slowdowns when investor sentiment turns risk-averse.

Furthermore, assuming that a company going public must be financially stable is overly simplistic. While IPOs have audited financials, the future stability and predictability of these financials remain uncertain. Factors beyond the company's control, such as global growth, tariffs, government regulation, and economic cycles, can significantly affect a company's fortunes.

It is also a misconception that only individual investors are awarded IPO shares. In reality, institutional investors and fund managers tend to be the primary purchasers in an IPO. Investment bankers aim to place IPO shares with investors who have longer time horizons, reducing share price volatility. As a result, individual investors may have to wait for the secondary market to buy shares after the IPO.

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While investing in an IPO may seem like getting in on the ground floor, it's important to note that private investors often have access before the IPO. IPO investors are among the first public owners of the company but not the absolute first. Additionally, there can be a difference between the IPO offering price and the price individual investors pay once the shares start trading on an exchange. The offering price is reserved for institutional investors, employees, and eligible investors.

Understanding these IPO realities is crucial. If you're still interested in a particular IPO, mark your calendar for the date when shares become available on the market. Depending on share availability, you can make purchases through a brokerage account. Another option is to consider investing in small-/mid-cap growth mutual funds, which actively participate in IPOs.

Terry Sandven, chief equity strategist for U.S. Bank, advises potential IPO investors to be cautious and knowledgeable about the company, its growth drivers, competitive landscape, valuations of similar companies, and company-specific risks. Not all IPOs are equal, and the future of IPO companies is often uncertain, influenced by various factors beyond their control.

In conclusion, investing in an IPO requires careful consideration and research. It is not a guaranteed pathway to success, and the risks involved should be thoroughly evaluated.

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