Potential Benefits of IPO Participation
IPOs can be attractive because they can offer:
- Early Access to Innovative Companies: IPOs can put you closer to the beginning of a company’s public-market growth story, when new products, new markets, and scaling revenue can drive attractive return potential over time.
- A Shot at the Offering Price, If You Receive Shares: Investors who receive an allocation buy at the IPO price, rather than at an unpredictable aftermarket price once the stock begins trading.
- Portfolio Diversification: Many portfolios end up concentrated in long-established names. IPOs may offer exposure to newer public companies whose performance drivers may differ from the most widely held stocks, particularly if new shares represent different equity sectors or investing styles. Just remember not to let any single IPO become too large a part of your portfolio.
- A Chance to Put a Strategy to Work: For active investors, IPOs offer a chance to plan: deciding in advance what price you are willing to pay, what would make you add or cut back, and what kind of position size fits your risk tolerance. The fact that the stock is “new” does not remove risk, but it can create clearer decision points.
Risk Considerations
The upside potential is why IPOs draw crowds. The tradeoffs are why it pays to know the rules of the road. Some potential drawbacks:
- Limited Number of Shares for Investors Seeking an IPO Allocation: In popular offerings, demand can quickly outstrip supply. Even if you are eligible to buy at the offering and submit a conditional offer for an allocation, availability can be limited and participation is not guaranteed.
- Volatility: IPO shares often move sharply in the first days of trading as buyers and sellers set a market price, sometimes falling below the offering price.
- Speculative Nature: IPOs typically involve companies that are smaller and newer, with limited operating histories, less experienced management teams, and fewer products or customers.
- Consequences for Selling Too Quickly: Brokerages that offer IPO allocations have “anti-flipping” policies that discourage early resales and may limit your ability to receive future IPO allocations if you sell too soon.
- Lockups Later On: Insiders and early investors are often restricted from selling for a period of time, commonly about 180 days. When lockups expire, additional shares can become eligible for sale and may affect the share price.
Do Your Homework
If you’re considering requesting an IPO allocation or buying soon after trading begins, it’s essential to perform due diligence.
Start with the prospectus. Reviewing the prospectus is important in order to make informed investment decisions. Make sure you understand the basics, looking in particular for “risk factors,” plus information on how the business makes money, what competition looks like, and how the company plans to use the IPO proceeds.
Also look for any discussion of lockups and when additional shares may become eligible for sale, because those calendar dates can impact the share price weeks or months after the debut.
Bottom Line
For individual investors, IPOs can offer a convenient way to request shares at the offering price, and IPOs can be seen as exciting opportunities, but you should know what to expect and understand the risks: Allocations are not guaranteed, prices can fluctuate widely, and deal-specific restrictions matter. Know the process, read the prospectus, and match your approach to your risk tolerance.
Please contact your Morgan Stanley Financial Advisor to learn more or visit E*TRADE’s New Issue Center to sign up for alerts about upcoming deals offered by E*TRADE from Morgan Stanley.
