How to price an initial public offering (IPO)

An initial public offering (IPO) is the process of transforming a private company into a listed company whose shares are listed and traded on a stock exchange. This process is sometimes referred to as “going public.” After a private company becomes a public company, it is owned by the shareholders who purchase its shares.

Many investors participating in an IPO do not understand the process of determining the value of a company. Before the public offering of stocks, hire investment banks to determine the value of the company and its stocks before listing on the exchange.

As an investor, it can be challenging to analyze a company that has newly issued shares that have not previously been traded on an exchange. But smart investors can try to understand the company’s financial status by looking at the company’s registration documents and assessing the company’s financial status to determine whether the stock price is appropriate. In addition, understanding how investment banks conduct the various components of a company’s IPO valuation is important for anyone interested in becoming an early investor.

Key points

  • In addition to the demand for company stocks, there are several other factors that determine IPO valuations, including industry comparability, growth prospects, and company narratives.
  • Sometimes, the actual fundamentals of a company may be obscured by its marketing activities, which is why it is so important for early investors to review the company’s financial statements; part of the IPO process is to require the company to prepare a balance sheet, income statement, and cash for the public Flow meter.
  • One of the challenges of investing in IPOs is that these companies usually do not have a long-term history of disclosing financial information and no established transaction history, so it is impossible to analyze them using traditional methods.

Components of IPO valuation

A successful IPO depends on consumer demand for company stock. Strong demand for the company will lead to higher stock prices. In addition to the demand for company stocks, there are several other factors that determine the valuation of an IPO, including industry comparability, growth prospects, and the company’s story.

Require

The strong demand for company stock does not necessarily mean that the company is more valuable. However, this does mean that the company will have a higher valuation. IPO valuation is the process by which analysts determine the fair value of a company’s stock.

Just because of the IPO time and market demand, two identical companies may have very different IPO valuations. A company usually only conducts an IPO when it determines that the demand for its stock is high.

In 2000, at the peak of the bubble, many technology companies conducted large-scale IPO valuations. Compared with companies in the evening market, they have obtained higher valuations and therefore more investment capital. This is mainly because technology stocks were trending in the early 2000s and demand was particularly high; this does not necessarily reflect the superiority of these companies.

Industry comparison

Industry comparability is another aspect of the IPO valuation process. If the IPO candidate’s field has comparable listed companies, the IPO valuation will include a comparison of the valuation multiples of its competitors. The reason is that investors are willing to pay new companies entering the industry a similar amount to the amount they currently pay for existing companies.

Growth prospects

The IPO valuation depends to a large extent on the company’s future growth forecasts. The main motivation behind the IPO is to raise funds to fund further growth. The successful sale of an IPO often depends on the company’s forecast and whether it can actively expand.

Convincing corporate narrative

Not all factors that make up the valuation of an IPO are quantitative. The company’s story can be as strong as the company’s revenue forecast. The valuation process may consider whether a company is offering new products or services that may revolutionize the industry or be at the forefront of new business models.

A good example is the company that pioneered the Internet in the 1990s. Because they are promoting exciting new technologies, some of them have obtained multi-billion dollar valuations, even though they did not generate any revenue at the time.

Some companies may beautify their corporate narrative by adding industry veterans and consultants to their payroll, trying to give the impression of a growing company with experienced management.

Sometimes, the actual fundamentals of a company may be obscured by its marketing activities, which is why it is so important for early investors to review the company’s financial situation and realize the risks of investing in companies with no established transaction history.

The risk of investing in an IPO

The goal of an IPO is to sell a predetermined number of shares at the best price. As a result, companies usually only conduct IPOs when the demand for their shares is expected to be high.

During the stock market decline from 2009 to 2010, the IPO market almost disappeared because stock valuations in the entire market were very low.

When the demand for the company’s stock is favorable, the hype surrounding the company’s products is always likely to obscure its fundamentals. This creates favorable conditions for the company to raise funds, but it is not good for investors who buy stocks.

When investing in an IPO, don’t be swayed by media hype and news reports. When Groupon, Inc. (GRPN) made its debut in January 2011, local coupon services were widely touted as the next trend. On the date of the initial public offering, Groupon’s stock opened at approximately $524 (after split adjustment). After that, it continued to fall and continued to fall-in January 2020, it was trading at an all-time low of approximately $11.00 per share. However, since that low, it has rebounded to around $40 in 2021.

An IPO is no different from any other investment; investors need to conduct research before investing any capital. Reviewing the prospectus and financial statements is a good first step. One of the challenges of investing in IPOs is that these companies usually have not been established for a long time, and their history of disclosing financial information is not long. However, part of the process of initiating an IPO is to require the company to prepare a balance sheet, income statement, and cash flow statement for the public.

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