Here’s what you should know about Initial Public Offerings

Getting in on the “ground floor” is what interests many investors in companies that have just made their stock available to the public. These so-called Initial Public Offerings (IPOs) often draw significant attention, particularly when well-known companies are involved.

IPOs are a way in which firms make their stock available to the public as a way to raise capital. They also allow individuals and entities who invested in the company when it was private to sell shares on the open market. If you are interested in IPOs and want to learn more, here’s what you should know.

Investing in an IPO stock

One appeal of IPOs for investors is the ability to own publicly traded stock at the earliest opportunity. Many do so with the assumption that over time, the stock will increase in value, and they wish to take advantage of what may be the lowest price available. But as with most investments, there is no guarantee that a profit will be generated.

Depending on the stock’s popularity, it may also be difficult to purchase shares when the stock is first traded. Typically, large institutions and higher-net-worth individual investors will have the best opportunity to participate in the initial offering. Talk to your financial professional if you have interest in a specific IPO to determine if you have the ability to obtain shares at the initial offering price.

Do your homework

Here are three key factors to consider as you assess whether to put money to work in an IPO.

FACTOR NO. 1 >> Prospects for the company

IPOs typically involve younger companies, but in some cases, they are firms with longer track records. Either way, information about such a company may be limited. It is important to carefully read the prospectus, learn about the quality of the firm’s management and assess the marketplace that the company serves.

Anytime you invest in stocks, a generally accepted practice is that you should only buy if you intend to hold the stock for at least five to seven years. This is just as true in the case of an IPO stock.

You want a sense of confidence that over time, the company has strong potential for long-term success.

FACTOR NO. 2 >> The fairness of the initial offering price

You want to be confident that the initial public offering share price is fair and offers you reasonable potential of appreciation over time. The initial listing price is likely to quickly fluctuate based on supply and demand for the stock. If you are unable to invest at the initial offering price, you may be purchasing the stock for a higher or lower price, even on the same day of the initial offering.

FACTOR NO. 3 >> Your investment portfolio and time horizon

Anytime you invest in stocks, a generally accepted practice is that you should only buy if you intend to hold the stock for at least five to seven years. This is just as true in the case of an IPO stock. While you may have visions of making a “quick buck” by owning a stock early in its existence, there are no guarantees. Like any stock, newly-issued IPOs have the potential to fluctuate in value. Depending on the timing of your investment, the stock may drop in price, particularly if the broader stock market happens to experience a notable decline. Patience is important. It’s also essential to ensure you evaluate the purchase of an IPO stock in context of your overall portfolio and financial plan.

Be sure to consult with your financial advisor to determine if and how an IPO stock fits within your overall portfolio.

Bronwyn L. Martin is a Financial Advisor Chartered Financial Consultant with Martin’s Financial Consulting Group, a financial advisory practice of Ameriprise Financial Services Inc. in Kennett Square and Havre de Grace, Md. She specializes in fee-based financial planning and asset management strategies and has been in practice for 18 years. To contact her visit www.ameripriseadvisors.com/bronwyn.x.martin