Can investing in IPOs make you rich?

When healthcare firm Singapore O&G did an Initial Public Offering (IPO) in 2015, some investors made more than 150 per cent as shares shot up from 25¢ to 63.5¢. And when LinkedIn went public in an IPO in 2011, the share price rose more than 170 per cent. It’s little wonder, then, that investors view IPOs as a way to get rich quick.

Moreover, buying into a new company can be exciting. As US-based financial advisor Martin Tilliier describes it, “there always seem to be endless possibilities for growth. Every stock looks about to do a Google and appreciate exponentially!”

The reality, however, can be quite different.

HOW DOES AN IPO WORK?

An IPO is the process that turns a privately held company into a publicly traded company by listing shares on a stock exchange. Companies may choose to list their shares to raise capital, enhance their status or increase public awareness, according to Deloitte Consulting.

Companies that want to list their shares will usually work with an underwriter or placement agent to write a prospectus that describes the company and their plans for using the money. They then apply to the SGX or another exchange and complete the preparations needed to list their shares.

Investing in an IPO here is easy. Investors can start by reading the prospectus on the MAS or SGX website. They can then put enough funds in their bank account and submit an application for shares through online banking or an ATM at one of the banks handling the listing. If their application is successful, shares will be deposited to their account at the Central Depository (CDP).

Since the number of IPOs here is small and shares are often oversubscribed however, applicants may only receive a fraction of the number they apply for. Moreover, the shares you receive may not make you rich. Singapore O&G, for example, was oversubscribed by about 18 times. If you applied for 100,000 shares, received 5,000 for 25¢ apiece and then sold them at 63.5¢, you would have made about $1,900. Although it’s a nice gain, it’s hardly enough to become wealthy.

SHOULD YOU INVEST?

While the process for investing in an IPO is straightforward, the actual results are far from certain. Data from Shareinvestor.com shows that share prices for five out of nine IPOs here so far this year had increased as of mid-July, for example, with Acromec soaring by more than 200 per cent. On the other hand, share prices for ten of the thirteen IPOs last year had dropped by mid-July, with two decreasing by more than 70 per cent.

Potential investors should be aware of several issues that can make it difficult to profit from IPOs.

First, reliable information about the company is limited. As finance professional James Yeo wrote on investment advisory site Motley Fool Singapore, while IPOs may sometimes prove to be rewarding, they are not sure-wins and results vary. Investors have little or no access to information other than what is in the prospectus, Yeo wrote, and “underwriters are usually conjuring up the hype on the IPO in an attempt to sell it at the best possible price.”

Moreover, most retail investors have little chance of buying large numbers of shares at the offering price. When Acromec did its IPO, for example more than 25 million of the 27 million shares were allocated to investors in private placements and less than 2 million were available to the general public. Realistically, then, most investors can only buy a significant number of shares after they start trading.

INVESTING IN AN IPO

Investors who still want to buy shares after reading the prospectus for an IPO and analysing the company can take one of several actions.

One alternative is to apply for shares in the IPO, hope to receive them, and then sell them for a profit – or a loss.

Another is to wait for the initial hype to die down and buy shares after they start trading. While the best option is often to buy at the IPO offer price and sell on the first day of trading, there’s often a dip within several weeks or months after the first day of trading. You could then buy shares and hold them for the longer term.

If investing in a single IPO here seems less enticing, an alternative could be to buy an Exchange Traded Fund (ETF) overseas that invests in IPOs. While such ETFs are not available here yet, investors with access to US markets could purchase shares in an ETF such as First Trust IPOX-100 Index Fund.

WHAT SHOULD INVESTORS DO?

While hearing about people who have gotten rich may make IPOs seem enticing, it’s hard to get shares and the price can also go down. Rather than expecting to become wealthy from IPOs, potential investors may be better off focusing most of their efforts on longer-term investments with better prospects and just buying shares in an occasional IPO. After all, investors who bought shares in the Google IPO in 2004 would only have made 18 per cent the first day, whereas investors who bought shares shortly afterwards and held on could have made more than 1,500 per cent.