Home Money Investment Should you invest in an IPO? Cash raised by new UK stock market entrants hit a three-year high in 2017 – but a float is …

Should you invest in an IPO? Cash raised by new UK stock market entrants hit a three-year high in 2017 – but a float is …

16 min read

Investors piled billions into companies that listed on the London Stock Exchange in 2017 in the hope of backing the Apple, Facebook, or Asos of the future.

The total value of money raised by initial public offerings (IPOs) on the exchange soared to £15billion – marking a three-year high. This is, in part, attributable to the big rise in the number of newly-listed UK firms to 106 last year, up from 65 in 2016.  

But while investing in a company tipped to take the market by storm at the earliest stage possible might seem like a no-brainer, buying when firms float is a complicated area.

More than 100 companies floated on the London Stock Exchange in 2017, raising £15 billion

More than 100 companies floated on the London Stock Exchange in 2017, raising £15 billion

Valuing the company can prove difficult without a stock market track record, but at the same time valuations for floatations tend to be on the high side. 

The truth is many new stock market companies underperform the market until several years after listing and so the decision to jump into such investments is not to be taken lightly.

They have their own set of risks and opportunities that must be carefully considered.

What is an IPO

Put simply, an IPO marks the first time the owners of a company relinquish a fraction of their ownership and offer it to the public in a fundraising exercise for business expansion. The term initial public offering is an Americanism and traditionally in the UK it was referred to as ‘floatation’ or ‘going public’ for this reason.

Firms that have gone through this process are available for trading on public markets, such as the London Stock Exchange or Nasdaq.

The process can be whittled down to five key stages.

The first is the announcement of intention to float, and the second requires the company in question to devise and release a prospectus outlining its business processes and risks.

The application for shares begins at the third stage. This will remain open for a fixed period of time known as the offer period.

Fourth, once the offer period expires, applications are finalised and investors are allocated shares based on how much money they have pledged and other relevant scaling.

Finally, the company lists on a specified stock exchange and can be bought and sold like any other share or investment trust during normal market hours.  

Modest investors often find they can’t buy share direct in a company at IPO because shares are limited and that larger institutional investors are favoured by the company.

A way around this is to be a customer of the group of brokers involved in the application stage of the process or an online DIY platform or other brokers that have received an allocation to share with their clients.

Alternatively, an investor could wait until the company has officially floated but, at which time, demand for the share could inflate prices and result in overvaluations.

London Stock Exchange data on newly listed IPOs in 2016 and 2017 
Main Market & AIM 2017 2016 Change
Number of IPOs 106 65 63%
Money raised at IPO £15bn £5.7bn 164%
IPO & follow-on capital £40.9bn £30.2bn 36%
New company average performance 12.20% 18.50% -34%
Number of North American listings 20 3 567%
Number of investment vehicle IPOs 35 8 338%
Investment vehicle IPOs money raised £5bn £644m 677%
Source: London Stock Exchange

Why are IPOs risky investments? 

There’s often a lot of media coverage when a popular household brand is rumoured to float but history shows us that it is important not to get caught up in the hype.

At the height of the dotcom bubble in the late nineties/early noughties, many investors threw their money at online businesses with the expectation of making double or triple-digit gains.

These firms went to market with IPOs fetching huge prices that continued to scale but ultimately ended up disappointing investors in the long term once the bubble burst.  

Therefore, it is vital to scruntinise the price of an IPO to ensure that it is not being driven up by investor frenzy.

If the IPO is priced low, there is a good chance of getting in on the cheap and making a killing once it floats. Conversely, an overpriced IPO leaves little room for growth and negative company news could send your investment tumbling. 

You need to consider the reasons for listing and the finances and business plan behind a company to see if it is worth putting money into an IPO.

Some shares will be good for growth while others will be good income payers and provide a steady dividend each year. 

Doing your homework on established stocks is hard enough as it is because company reports and accounts are often littered with technical and investment jargon that can be difficult to decipher.

But carrying out due diligence on a firm that is about to list on a stock exchange is even harder. Private companies are not required to publicly disclose financial information making analysis on some key fundamentals nigh on impossible to do.

IPOs often involve investing in a business with little operating history so they may need additional due diligence

IPOs often involve investing in a business with little operating history so they may need additional due diligence

IPOs often involve investing in a business with little operating history so they may need additional due diligence

Your main source of data is the prospectus a company is required to release ahead of IPO, so it is important to study it carefully before investing. 

It is also worth scrutinising the credibility of the investment bank chosen to underwrite the whole process.

Leading investment banks such as Goldman Sachs and JPMorgan Chase boast scale and credibility, so they can afford to be choosy with the companies they underwrite. Whereas smaller rivals may adopt a more liberal approach.

This is not to say that the former are immune to bringing bad quality companies to the public. 

Justin Urquhart Stewart, co-founder and head of corporate development at Seven Investment Management (7IM) said: ‘Apart from the blindingly obvious IPO opportunity (few of which exist, but privatisations have counted as such in the past), I am cautious on IPOs. 

‘One year’s fashion fad can be next year’s tank top, so you have to be really convinced about the business case and in it for the long term. It’s important to make sure you are not just lining the pockets of the business owners (before they themselves move on to the next big idea).’

But it is not all doom and gloom

While it is right to tread carefully, shunning IPOs altogether can mean that investors miss out on new and emerging investment opportunities, according to Andrew Summers, head of fund research at Investec Wealth & Investment. 

Of course, if the company is successful an investor can always invest at a later stage, but they will likely have to stump up more cash to reflect the company’s success since IPO, he added.

Free investing guides

Simon Moore, senior investment manager at 7IM, said the key is for investors who have bought shares in a company at IPO is to be patient with their investment.  

The performance history of the Fidelity China Special Situations investment trust -which is a listed company with shares that trade on the stockmarket – demonstrates this point well.

The trust’s share price grew in the seven months after inception, but this gave way to a downturn resulting in a more than two-year spell where the company was trading below its IPO price.

However, those who invested at IPO and stuck by the trust would be rewarded with returns of around 240 per cent before costs if they chose to sell now (as at 3 January 2018).

‘As ever, investors need to take a long-term view,’ Moore, said.

‘And if your recently bought IPO falls to a discount to net asset value, remember that if the share price is higher than what you paid, you’ve still made money – some times more so than if you had sat on your hands waiting for the fund to fall to a discount.’

Another positive is there is no stamp duty to pay (usually 0.5 per cent) if you subscribe to a new issue of shares in a company and stockbroking commission payable on IPOs, which reduces the cost of purchase compared to buying UK stocks on the market. 

What’s more, most IPOs are available in an Isa and Sipp (self-invested personal pension), which shield income and gains from your investment from tax.

Laith Khalaf, senior analyst at Hargreaves Lansdown, said: ‘Companies launching onto the stock market tend to be towards the smaller end of the scale, which can add to risk but that also gives them the potential for high rates of growth too.

‘As with listed stocks, make sure you don’t put too much money in one company and maintain a diversified portfolio. IPOs can come with an exciting story attached but make sure you look at the sausage rather than just listening to the sizzle.

‘There’s nothing wrong with investors putting money into IPOs, as with any investment decision they just need to make sure they are making an informed decision and are happy with the risks.’


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