What is... | July 23, 2014

What is an IPO?

An initial public offering, or IPO, is when a company raises money by issuing shares in the market for the first time. Being the first – or initial – time is an important distinction, as companies can raise money after their first listing through secondary offerings.

A company might do an IPO to raise capital to help fund growth or to gain the recognition that often comes with being accepted onto a recognised share market.
But listing on a share market is not all plain sailing and there can be challenges for companies and investors alike. Being aware of these potential pitfalls – as well as the potential gains – is a key part of making informed money decisions.

The first time I listed…
The Dutch East India Company is widely acknowledged to be the first “modern” company to issue shares on a large scale, in the 1600s.
Many IPOs happened since then but following the global financial crisis that started in 2007, interest in IPOs waned. The economic recovery has since sparked a revival of interest, with a report by global professional services firm PwC finding the value of European IPOs in first half of 2014 hit the highest level since the first half of 2007.

Did you hear about the Twitter IPO?
Investing in shares carries a relatively high degree of financial risk and IPOs are no exception.
The IPO of social media firm Twitter rewarded early investors, for example, with shares up 73% on its first day of trading in November 2013, from $26 to $44.90. The share price at the time of writing, on 23rd July 2014, was $37.70. A similar pattern in share price can be observed during the eagerly awaited IPO of Royal Mail in October 2013. Which rose significantly on its debut and has since fallen.
However, the share market debut of King Digital Entertainment in the US is an example that did not do so well. The shares slumped 15% from the flotation price on the first day of trading in March 2014.
Of course, the first day of trading is no guarantee of where the share prices will eventually end up.

An alternative listing
In addition to the main share markets, such as the FTSE100 and the Dow Jones , there are alternative markets where many companies will list for the first time, such as the Alternative Investment Market (AIM) in the UK and NYSE Alternext in the US.
These markets may be even more volatile and can carry even higher risk.
These shares may be illiquid making them hard to sell quickly, because the buyers simply may not be there (think also of art, wine and stamp investments here). This is something for an individual to consider before investing . ING Group chief economist Mark Cliffe explains more about the importance of liquidity in his third video lesson from the financial crisis on liquidity.

Be wary of being swept up
The buzz around a new company joining the market might grab attention and encourage investors to “buy now”.
Be wary of making investing decisions influenced by a share being in the news, as doing so can be falling into the availability bias thinking trap.
Economist and writer Chris Dillow highlights the danger of “limited attention” in this eZonomics blog.
Similarly, friends and family might be caught up in the buzz and the rest of us can get swept along with them, and follow the crowd (also known as herd behaviour) - even though we haven’t weighed the risk and return or evaluated how buying into an IPO fits with our own financial goals. It might sound simple but this study of more than 87,000 private investors showed an individual is about one-fifth more likely to buy a particular stock in a month if other private investors are also buyers. The authors write that this herding behaviour occurs by tracking others’ trading patterns.

Do your homework
IPOs might be roaring successes or total flops.
There is often much excitement surrounding a float, particularly one that has received a lot of press coverage, but potential investors should ensure that they do their homework before investing, and not get carried away by the hype.
Research widely and question commonly accepted views.
And as always, do a stocktake of your money situation, tolerance to risk and financial goals before investing.
Try to remain calm and take the decision to invest in a cold state of mind.


eZonomics team
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