For UK retail investors seeking to get a piece of a company just as shares are made available for sale, an IPO or Initial Public Offering provides just this opportunity.
An IPO is a private company’s first offer to sell its shares to the general public and institutional investors. The shares for sale can either be in the form of new shares, or shares offered for sale by existing investors. An IPO signifies the point at which a company intends to become publicly listed on a Stock Exchange, however, at this point, shares are sold prior to hitting the stock market.
The advantage of investing in an IPO is that you stand to buy those shares at a discounted price, in the hope that those shares increase in value on their first day of trading. As an example, Pinterest experienced a sharp rise in share value by 25% by the close of trading when they listed on the New York Stock Exchange. Whilst this rise in value proved lucrative for investors who had traded on the IPO, as with all investments, this is not without risk, and there have been instances where the share value has fallen, such as is the case with Uber who experienced a 7.6% fall in share value at the end of the first trading day.
Generally speaking, companies will consider going public to raise capital and improve their public profile. Whilst the company will decide the volume of shares it wishes to list, it will fall in the lap of an investment bank to determine the price of those shares. The good news for retail investors is that previous restrictions which meant only institutional investors can participate in the primary market have now been lifted, paving the way for retail investment into IPOs.
How To Trade an IPO
In order to illustrate the order of operations when it comes to an IPO, we have used the example of PensionBee who have just recently announced their intention to float on the London Stock Exchange, and after a recent growth of 80% in value, could present an excellent opportunity. Please bear in mind that we are using PensionBee for illustrative purposes only and are in no way recommending that you trade in the PensionBee IPO as this is a decision based on speculation and a risk that only you can justify.
The option to gain exposure to PensionBee will be available through a number of providers, however, one of the providers we recommend for trading IPOs is IG Investments who are the only UK provider that allow you to take a position pre-IPO as well as participate in the IPO, and trade the stock once it’s fully listed.
How to take a position pre-IPO
IG Investments offer their customers a ‘Grey Market’ before the IPO of a company takes place. This is only in the case of increased public interest in a company’s IPO and allows you to effectively speculate on the estimated market cap of that company at the end of its first day of trading. The market cap is the value of that company as determined by the stock market.
The way the ‘Grey Market’ works is that IG Investments will quote a price which is based on their forecast of what PensionBee’s market cap will be at the end of the first day of trading. Should you predict that PensionBee’s market cap will be higher than the price quoted by IG, then you will ‘buy’ (go long), however, should you predict the price will be lower you will ‘sell’ (go short).
How to take a position during an IPO
Once the company has filed for an IPO you can take a position using the ‘Primary Market’. In this instance, you could subscribe to the PensionBee IPO ahead of the offering through IG’s partnership with PrimaryBid. You will then receive a stock allocation at the same time as institutional investors. Within the primary market, you will be purchasing your shares direct from PensionBee, before retail investors have the opportunity to buy and sell the stock between themselves.
Buying the stock after the IPO
Once the IPO has taken place the PensionBee stock will be listed on the London Stock Exchange and will be available to buy and sell in the usual way.
Of course, the hope is that once the PensionBee stock is listed on the Stock Exchange, a flurry of activity will drive the price of the stock up, giving anyone who has taken up a position before, or during the IPO, an immediate return. Much of this depends on speculation and therefore trading on IPOs is considered a very risky endeavour. In order to mitigate your risk, it is wise to ensure you have an understanding of the fundamentals of the company’s business.
If you are a long term investor who believes the company has elemental value, then you may be less concerned with the initial fluctuations in price, however, it can sometimes be prudent to wait until the initial excitement of an IPO has passed and the price has started to settle down before risking your capital on stock.
What are the risks?
Many investors will be wondering how potentially lucrative it can be to trade IPOs. This all depends on your ability to predict share price movements. CFDs and spread bets can be used to speculate on the grey market, however, these are complex instruments and 75% of retail investors lose money when trading with spread bets and CFDs. Analysis from investment bank UBS found that of more than 7,000 companies that had IPOs between 1975 and 2011, around 60% had negative total returns after five years of being publicly traded.