How Does an IPO Affect Stock Value?

An initial public offering, commonly referred to as an IPO, is the first batch of stock in any company that is offered to the investing public. Companies normally choose to "go public" to gain a broader base of financing to pursue growth and larger projects. Becoming a publicly traded company can have a wide variety of both long- and short-term effects on a company's general well-being, including the price at which its stocks are traded.

Public Value

The general investing public - people and entities that are likely to buy into an IPO - has a sense of how much they are willing to pay per share of a company's initial offering. Often, this price doesn't line up with the price that the company is charging, since company insiders and the investing public have different information to base the value on. If the public thinks the IPO is overvalued and hesitates to buy it, the abundant supply of new stock and the lack of demand might cause the value of the stock to drop sharply. On the other hand, if the public is scrambling to buy a new offering, the show of demand could drive the price up significantly.

Public Scrutiny

Going public opens up the company to much more pervasive scrutiny. Since the company is now open to public investment, its operations are considered the business of the public. This can have a number of effects on stock prices. Financial strain from hiring more lawyers, accountants and record keepers can have an effect. Revelations about unsavory business practices, questionable finances or poor management can open up companies to huge sell-offs and plummeting stock prices. By the same token, some investigation could reveal the true strength of a company to the public, encouraging a much broader base of investment.

Lockup

Normally there is a grace period after an IPO during which the original private investors and company insiders are barred from selling all of their stocks. This is to prevent insiders from waiting for the public to invest and then cashing in at the expense of new investors. However, selling can still have a dramatic effect after the lockup period, which is normally six months long. This doesn't necessarily mean that the company is in ill health. Often, investors just want to cash in on at least a chunk of their shares to give them some cash. However, this can still have a big psychological effect that pushes down the stock price. On the other hand, primary investors could hold their shares and drive the price up.

Expansion of Operations

As noted earlier, one of the primary reasons for a company to go public is to increase liquidity or access to finance to undertake bigger projects and expansion. If a company's fundamentals are sound, and it implements a solid plan for expansion, there is no reason that an IPO should not result in successful, sometimes even enormous growth. While stock price is not guaranteed to rise and fall with the general success and fortunes of the company, there is normally a strong correlation. That means that a solid company, at least over the longer term, should see a significant increase in stock prices after going public.