Evaluating IPO

Posted by Alex Rowe on March 4, 2013

Anyone interested in investing knows that IPO is a company’s initial public offering- the price they first sell shares for on the stock market. Companies must adhere to federal securities law by registering any transactions with the Securities and Exchange Commission.  Here is a general high-level guideline for evaluating the quality, merit, and fairness of a company’s IPO to help you can make educated investments.

 

While filing for an IPO in the US, companies must provide a “prospectus” to the SEC which is a document that describes the company, IPO terms, and any other relevant information the investors may need to know. Always be sure to read the prospectus so you can be informed on the terms and disclosures of the company’s business, the state of their finances, and other important factors such as details about the management team, company direction, etc.

 

Although the SEC reads and edits the prospectus’ to make sure it complies with their rules, it does not fact check the accuracy of any of the claims being made. This is why it is the investors responsibility to do their research and ensure the information they are being provided is reasonable by their own standards. To this extent, rule #1 - Do your research: All companies undertaking an IPO have their registration information available through the SEC’s EDGAR database at www.sec.gov/edgar/searchedgar/webusers.htm. Look specifically for a 424B3 or 424B4 in the database, which is the company’s final version of their prospectus. Once the registration becomes effective, SEC staff will add comment letters regarding the company’s filing that you can read and consider when making an investment decision.

 

The SEC recently released an article highlighting some key points to look for which include:

 

-Prospectus Summary: Break down of the business strategy, IPO terms, and how they plan to use the funds they raise.

-Risk Factors: Highlights any risks that management feels could influence the business they conduct.

-Use of Proceeds: Where the funds will go once shares are sold.

-Dividend Policy: Should include company’s payment history and future payments to shareholders.

-Dilution: Compares the IPO to the book value and average value of shares.

-Selected Financial Data: 2-5 previous years of key financial data.

-Management Discussion and Analysis: Narrative notes from the management explaining how and why the company has changed over time, and where they see it heading in the future.

-Business: Explains the business and its products or services, important suppliers and customers, and competition. Be sure to note the ‘Legal Proceedings’ section, which will disclose any relevant active litigation issues.

-Management: Biographies on the management team.

-Financial Statements and Notes: Audited financial reports as well as an independent auditor’s opinion about the financials presented.

Tags: financial risk, investing, IPO, shareholder, prospectus, EDGAR database