Question

Evaluate the risk / reward position to an investor when purchasing stock during an initial public offering, indicating under what circumstances you would advise an investor to do so.

Answer 1

IPOs can deliver returns; they also carry serious risks for even for the experienced investors. Some things to consider when thinking about investing in a new public company is to understand the business model, the fundamentals and the management team. By reading the prospectus, an investor can check out the growth and potential earnings of the company this can help to understand the succession over the competition. When investing in an IPO there are no guarantees, understand those reasons as to why they may underperform. An example is Groupon, who was a highly anticipated IPO in 2011 with shares at $20; it rarely moved above that price and had been trading under $10 a share for most of 2014. They show how an IPO can get overvalued because of media hype. Underwriters can price IPO shares above what the company’s price-to-earnings ratio that can lead to prices not being maintained once on the secondary market.  
There can be a lack of history or information for new-to-market securities. They may not have the historical performance or data, or other important details publicly traded securities are required to offer. A private company may disclose a fair amount of information, but it can still be challenging to predict how the company will perform after an IPO.  
The benefits of buying into an IPO are for the advantage of being the first. Buying shares early on of a company when the investor believes it has long-term potential would be cheaper. Some of the most valuable companies have seen their stock value increase tremendously since going public. For instance, since Mexican restaurant chain Chipotle went public in January 2006, its stock has risen well over 1,000 percent. Had an investor bought shares in the IPO, Chipotle may have been among their portfolio’s all-star performers.
Evaluating the risks and rewards to an investor when purchasing stock during an IPO are vital, doing the research and knowing the history and future of the company are vital.