After cutting through the initial rush of excitement that often accompanies a public offering security’s debut, a common result is that zealous investors may have inordinately influenced its market price. But the value of shares of an IPO is more closely aligned with the stock’s actual book value than with its investor sentiment-driven markup. If you go back to basics by analyzing the IPO's prospectus and objectively reviewing its balance sheet, you’ll be able to calculate its share value a little more realistically by looking at the tangible value of its assets.
You can determine the value of shares in an IPO by dividing the number of shares sold by the sum total of paid-in capital.
Ride Out the Honeymoon Phase
Don’t get caught up in the excitement surrounding an IPO or you might forever be waiting to break even after the company's stock price flounders when the IPO euphoria wears off. Generally, the price of shares is set by the usual forces of supply and demand. IPO shares are no exception and will sell for whatever price an investor is willing to pay for them.
If you suspect that the share price is unnaturally high, it's a good idea to wait until the IPO euphoria is over to see if the stock price falls in response to the market’s new perception of the stock’s value.
Some Questions to Ask
Ask yourself, "Why has the company elected to go public? What is its operating history, if any? What are its growth prospects? What's the competitive environment?" Use the answers to these questions to help influence your investment decisions.
Reviewing the Prospectus
Contact the investment bank that's underwriting the IPO, and request a copy of the prospectus to review the IPO's financial data. The investor may send you a digital version, or it may mail you a paper copy.
You'll likely be able to find the prospectus online. When a company offers an IPO, it must first register its offer and sale of securities with the Securities and Exchange Commission by filing a registration statement. Its prospectus is part of this registration statement. Visit SEC.gov and search for "EDGAR," which is the Electronic Data Gathering, Analysis and Retrieval tool, to lookup and find a company's prospectus. You'll be able to search by the company name or its stock ticker symbol.
Now for a Little Math
In the prospectus, locate the balance sheet and find the stockholder’s equity section, where you'll see an amount under the “paid-in capital” heading. This represents the money that the company has received from the sale of IPO stock. Find the number of shares the company has sold in the stockholder’s equity section of the IPO's prospectus.
Divide this number of shares sold by the amount of the paid-in capital to get the value of one share of stock. For example, if the company has sold 25,000 IPO stock shares for $500,000, you would divide the $500,000 paid-in capital amount by 25,000 shares to arrive at a $20-per-share book value. This book value represents a more-accurate valuation of shares than the feeding frenzy markup that often accompanies an IPO's debut.
An IPO's Qualitative Factors
Certain qualitative factors can affect an IPO's share price beyond its quantitative factors. For example, market perception can assign a higher value to a high-tech company over a solar-panel manufacturing company because investors are more attracted to high-tech. An IPO company can hire well-known and experienced industry personnel to sit on its board of directors, which gives the appearance that the company is led by competent professionals.
Be aware that although qualitative factors can increase or decrease the market’s perception of what the stock is worth, the actual quantitative book value remains unchanged. Investors must decide for themselves if the IPO stock is worth purchasing at a market-inflated price.
Items you will need
- IPO prospectus
- Consider waiting until the IPO euphoria is over to see if the stock price falls in response to the market’s new perception of the stock’s value.
- Don’t get caught up in the excitement surrounding an IPO, or you might forever be waiting to break even after the company's stock price flounders after the IPO euphoria wears off.
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