Everyone wants to be the first person to back the next big thing. It’s a wonderful feeling to be able to look at a huge company – like Facebook or LinkedIn – and be able to say, “I was there at the beginning!”

The problem is, not every new company will be a winner, and that’s kind of the rule of success. If everyone can be a winner, then no one is a winner, right?

Initial Public Offering

(Raten-Kauf / pixabay)

The majority of companies that step onto the main stage and offer investment opportunities will fail. It doesn’t sound kind, but unfortunately, that’s business, baby.

So, this means that every time we invest in an initial public offering (IPO), we are shouldering a big risk and a big risk that has the prospect of reaping even bigger rewards. If you are considering taking a dip into the pool of IPOs as part of your wealth building plan, I have put together a few important questions that you should be asking.

Is the Company Ready for the Big Time?

It seems like a fair assumption that any company putting forward its first IPO is ready to take a stand amongst the hard-hitters in their industries. If they are willing to let the public invest in them, they must be pretty stable and profitable, right?

Unfortunately, this is a naïve way to look at it. While the company may have done well enough to earn and grow well, this by no means guarantees any security.

A company’s success rests on a long list of variable factors—the state of the global economy, shifts in international relations, and changes within the government will all affect company operations. The unpredictability of these factors can lead to a profitable company collapsing overnight.

With all this in mind, you should always take the time to consider if any potential factors might result in a downfall. Sure, it’s impossible to predict the future, but a little logic can help you identify riskier projects.

For example, retail companies are notorious for not being successful during IPOs. Similarly, businesses whose main focus is COVID 19-related products are likely to see a decline in success in the near future.

Am I Getting the Right Tips?

Nowadays, you’ll come across various tips for freshly presented IPOs. You might get them from ads featured on TV, or through investment apps, or even certain brokers. The problem here is that most of them are given by people who work for trading concerns that profit from your loss.

Many trading apps, in particular, are notorious for this. The best way you can avoid getting stung is to avoid them. Ignore any sudden notifications or publicly broadcasted “hot tips,” and instead, do your own research and make your own decisions.

It’s also worth mentioning that an expert who’s getting a lot of engagement isn’t necessarily calling the right shots. It can be easy to be swept up in the mass hype created by a community, but it’s important to tread carefully and conduct due diligence on the company whose IPO appeals to you.

Are Quick Returns Possible?

Fast returns are one of the biggest lures of an IPO. Just last year, the IPO of Burger King shot up by more than 100% on the first day of its listing. However, the price later plateaued, leaving holders scratching their heads. To prevent this from happening, look at IPO investing from a long-term perspective. Figure out if there’s potential in the company, rather than worrying about the losses or gains on listing.

Is the company doing well? Will it be able to increase its market share and revenues consistently? What’s its strategic advantage? Finding answers to these questions will help you determine whether you’re investing in the right stock.

Should I Even Invest in an IPO?

Sometimes, even if a certain IPO looks promising, it is best to sit back and wait. Most companies will make their first IPO when they are their strongest, which helps build a much better image for themselves. Unfortunately, this often leads to pressure and public hype they cannot live up to, earning a good burst of money on day one and little thereafter. The companies you want to back are the ones that can outlast this initial burst.

Hold off and watch. Give the company a year, and if they are still available and looking strong after that, you know they are something good. It takes a solid business to be able to make it out of their first year. To quote Chief Equity Strategist for U.S. Bank Terry Sandven, “The company path toward financial greatness is littered with failed IPOs.”

Final Verdict

Deciding to invest in an IPO is a decidedly risky one that is not for the faint of heart. It can be troublesome to even get into a position to acquire them, and the return may not be as stellar or life-changing as you might hope. They certainly aren’t the kind of investing you can hope to live your life on, but they are one of investing’s more exciting endeavors. Hopefully, if you have decided that IPO trading is for you, then these words of advice will help you make the right decision.