A stock’s market price in an initial public offering does not necessarily reflect what the shares are worth. Investors can get overly excited over a hot new company and push the share price higher than the stock’s actual book value. You can use a number of methods to analyze IPOs, but the stock share value is normally based on the tangible value of the underlying assets. By using the balance-sheet information contained in the prospectus, prospective investors can calculate an accurate share value to help determine whether the market has correctly priced the IPO shares.
Contact the investment bank underwriting the IPO and request a copy of the prospectus. Find the financial data contained in the prospectus. Locate the balance sheet and find the stockholder’s equity section. Look for the amount under the “paid-in capital” heading, which is the money the company has received from the sale of IPO stock. As an example, let’s say the balance sheet reports $500,000 as the amount of “paid-in capital.”
Locate the number of shares the company has sold in the stockholder’s equity section. Divide the 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 25,000 shares by the $500,000 paid-in capital amount to arrive at a $20-per-share book value.
Consider the qualitative factors that can affect an IPOs share price. 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 their 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 book value remains unchanged. Investors must decide for themselves if the IPO stock is worth purchasing at a market-inflated price.
Generally, the price of shares is set by the usual forces of supply and demand. IPO shares 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.
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. 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 influence your investment decisions.
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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