There is no doubt that you can make some serious cash investing in an Initial Public Offering.  Recent floater Pacific Smiles is one such case of a success story. The company was originally listed at $1.30 and climbed as high as $1.75 on opening day! A sexy 35% return for those who decided to sell at this point. However if you were looking at holding the stock for a bit longer you would have seen the price rise to a high of $1.90 before coming back down. The stock has since reached a peak of $2.55 or almost double its listing value. However not all IPO’s go to plan. The now infamous IPO of Facebook left many with a substantial loss and questioning the ethics of the company. After months of speculation where the stock was valued between$28 and $40, the underwriter of the listing settled at $38. This large spread should have been a warning sign for the following events. Facebook sold off more than they had planned to after listing which would see the stock tumble to $26.81 within a week. Almost a 30% decrease! Again if you were looking at the long term today Facebook trades around $133 or almost $100 per share higher than its listing price is just over 4 years.

So it’s clear that there is money to be made investing in IPO’s but there are certain steps that you should follow to maximise your opportunity for a seriously good return.

Step 1You need to be in the know.

Ideally you want to be able to have access to shares at their cheapest point. Unfortunately this can be limited to sophisticated investors. Despite this you can sign up to receive information from companies such as Commsec who deliver emails about upcoming floats. Once you identify a company that you want more information about you could then identify who is handling the listing and contact them directly. Alternatively you can wait to trade them on the ASX the day that they have gone public.

Step 2 – Understand the company and what it does.

I was very interested in the Godfrey’s IPO. When I think of places to buy a vacuum cleaner from Godfreys is first to mind. This is the type of positing you want your IPO to have, being number 1 in the mind of the consumer. However, as I went around to a few different Godfrey stores to better understand their customer service and sales approach I found something very concerning. They didn’t stock Dyson. Dyson is the Apple of vacuum cleaners. Imagine opening a computer store that didn’t stock Apple products. I wouldn’t have a lot of confidence in its price exploding. Turns out this assumption was correct. Since listing at $2.75 per share the stock currently trades at a mere 84c! Meanwhile Dyson has dominated sales in this market.  This is one of the most important things when investing in general. Understand the company and its strategic positon.

Step 3 – Valuation

This can be very much of an art more so than an exact science. Very much up to the individual’s interpretation.  A prime example was when Medibank listed at $2.22 per share after it had been offered to retail investors for just $2 per share. This also emphasises the importance of being in the know. Imagine buying for $2 and it lists at $2.22. An 11% gain for nothing. This stock was always going to be a Bluechip company.  Since listing shares in Medibank have traded between $1.75 and $3.75 but currently sits at $2.64. This represents an increase of 19% over two years which in today’s market is ok. However as investing in IPO’s is riskier than already listed companies a return of 8.5% doesn’t reflect an adequate risk to reward ratio.

Step 4 – Understand the plans of management

As mentioned above Facebook were planning on selling off shares after the IPO. This is generally seen as a questionable tactic as it alludes to a lack of confidence shown by the founding team. It can emphasise their long term plans if they sell a large percentage of their shares not long after the IPO and is often slap in the face to investors as they cash in and get out whilst others are getting in. It’s the number or percentage of shares that are looking to be sold that are important. You can hardly blame a founder who has struggled for years cash in a take a little back when there is the cash to do so. But if a founder is going to sell ownership from 50% to 10% than this should be a warning.

One success story of a committed founder is Matt Barrie of Freelancer. Barrie made it clear from the get go that he was fully committed to the business. The result?  Shares in Freelancer went from 50c to $2.50 on its first day on the stock market. It went up 5 times in value! What a pay day. It currently sits around $1.25 still an impressive 2.5x listing price in less than 3 years after listing. That’s a much better risk to reward ratio for investing in IPO’s.

Step 5 – Look at the management and senior executive team

This is one of my go to strategies and is in fact the main reason I invested in Yellow Brick Road. YBR is a company founded by Mark Bouris who had tremendous success with Wizard Home Loans.  I backed Bouris to deliver and execute on strategy more so than the company itself YBR listed for 20c per share and I got out 18 months later when it hit $0.70c per share as the business looked at changing strategy. Having an executive or a board of people with a track record in success puts the investment in a better position of paying off.

So it’s clear that buying into IPO’s can be a very lucrative pay day if the investor can pull it off. But with most things in the investing world there is an inherited amount of risk associated with each investments and IPOs are no different. Follow the steps above to give you a better insight into a company looking to list but it would be worth getting an expert opinion from an advisor or broker before committing you hard earned cash on a risky investment strategy.

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Phil is the Founder of Cheeky Investor and self-appointed CEO of Sales and Investment Education for Australia. He covers a range of corporate education topics through his own blog.

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