Personal Finance & Money Asked on November 30, 2020
When the company makes the initial public offering (IPO) the prices of stocks in the first days are usually more volatile in average, than for the established business. In the book The Intelligent Investor, B. Graham even recommends never to accept a risk of buying the stocks during the first period.
However, the choice, whether to invest or not, is an investor’s decision, and in case he is well acquainted with the current state of affairs of the business and is confident in future prospects of the company, one may accept this risk for a potentially high income in the future.
The question is, how to estimate, whether the price of the stocks, offered before the IPO is a reasonable one, or overestimated? Whether it would be more sensible to buy the stocks before the IPO, or during some time, when the price, being overestimated, or due to some uncertainty on the market drops slightly?
I know, that there is no general working recipe, as the market is unpredictable to a certain extent even for professionals, but what would more sensible to do in some averaged case?
The short answer is that demand for the IPO determines whether the price of the stocks, offered before the IPO is a reasonable one, or overestimated.
During the late 1990s internet, I did a lot of IPOs. At that time, I subscribed to an IPO newsletter/service that accurately ranked expected opening price performance. The basis of the evaluation was tracking how well the underwriters were doing with orders received (demand) during the road show. Here's an excerpt from Investopedia article that explains the basics:
The underwriting agreement can take a number of different shapes. The most common type of underwriting agreement is a firm commitment in which the underwriter agrees to assume the risk of buying the entire inventory of stock issued in the IPO and sell to the public at the IPO price. Often, there is a group of underwriters for an IPO that shares in the risk for the offering, called the syndicate...
The underwriter then creates a draft prospectus to take on a road show to potential institutional investors. The road show seeks to create excitement for the IPO and involves conferences given to investors around the country. After the road show, the underwriter and company determine of the final price for the IPO based on the orders received during the road show.
This was my approach and it worked well. Since I have moved onto other financial endeavors, I have no clue if something as reliable as this still exists. In lieu of this approach, one would have to be really adept at the financial analysis of a prospectus, something that I think the vast majority of retail investors/traders are not qualified for.
Correct answer by Bob Baerker on November 30, 2020
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