This weekend, rumours began swirling about a possible Klarna IPO. With this on the front of the news amongst other companies recently listing, what exactly is an IPO?

An Initial Public Offering (IPO) is when a company sells its shares on the stock market for the first time.

You’ll usually see a load of once-in-a-lifetime marketing fanfare. But for investors, deciding whether to invest in an IPO or not should carry the same diligence as deciding to buy any other investment, if not more.

Ultimately, you’re trying to determine whether the stock is reasonably valued. Unlike shares that have been trading for years, IPO stocks don’t have as much widely-published information. This makes it harder to make a well-informed decision on whether an IPO is right for you.

And with all the hype that surrounds them, it’s easy to get caught up in the storm. But is it worth it?

This is not personal advice. If you're not sure if an investment is right for you, please seek advice. The value of all investments will fall as well as rise, so you could get back less than you invest.

You should only invest in an IPO based off the information provided in the prospectus and if you fully understand the risks involved.

How do IPOs work?

Before delving into the hype, it’s important to understand what an IPO is and how it works.

When a company IPOs, it goes from a private company to a public one that’s listed on the stock market. But, before making the jump to a Public Limited Company (PLC), there are some hoops it has to jump through.

The company announces its intention to float on a stock market through an IPO.
A prospectus is released – this has all the financial documents, business risks and supplementary information about the company.
Sale of shares – the IPO is open for its ‘offer period’, a fixed timeframe where investors can apply for shares.
‘Offer period’ ends – applications for shares are finalised, the final price is announced and investors are allocated their portion. This can be subject to ‘scaling back’ – this means you get allocated fewer shares than you applied for if the IPO is oversubscribed.
The company then lists on the stock market (also known as the secondary market) – following the end of the IPO, the company can then be bought and sold during market opening hours, like any other share.

What is the IPO hype?

There’s a surprising number of large companies still privately owned, meaning you can’t buy them on the stock market.

Because of this, the rumour mill is ever churning on financial streets like Wall Street or Canary Wharf. Inevitably leading to big names being whispered around forums and chatrooms.

For many, it’s a slow burn.

To build the most anticipation around your company, IPOs can take a long time before the wheels are fully set in motion. Recently, we’ve seen companies like Reddit file the necessary paperwork for an IPO in 2021 with an aim to announce in the second half of 2023. Since then, it’s been radio silence.

Do IPOs live up to the hype?

One of the most talked about IPOs of the last few years was the Softbank-owned Arm Holdings. The IPO took place in September with a price of $51 per share. After listing, the stock opened at $56.10 per share and its price rose as much as 25% higher during its first day of trading.

But for the following five days, it suffered consecutive daily falls. It then fell further and has only recently recovered to near its IPO price.

Instacart is another big-ticket IPO from across the pond. Formerly Maplebear, the grocers had an IPO launch price of $30 per share. Almost $660 million was raised as part of the IPO. But, by two weeks after launch, the price had dropped by 4% and now, it’s around $27 per share.

On average after an IPO, three quarters of retail investors hold their investment for at least a year. Well under half hold it for at least three years.

A study by Nasdaq showed that almost two-thirds of US IPOs from 2010 to 2020 underperformed the market over three years.

While IPOs have raised $19bn in the US so far for 2023, the biggest hitters Arm, Instacart and more recently, Birkenstock, have all fallen below their IPO prices with only Arm recently recovering.

This follows a trend where interest has waned, and the number of traditional IPOs has been dropping in the US. Fewer IPOs could lead to more hype for those that do end up listing.

Source: Dealogic as of 31/10/23.

Keep a long-term view

IPOs and the interest they create can be a great way to create investing hype but it could be easy to get carried away. Investing is for the long term, that’s at least five years. However, most retail investors have been ditching their IPO stock just three years after buying.

Now this doesn’t mean that just because you take part in an IPO you need to keep the shares for at least five years. However, you need to be thinking about the long-term prospects for every investment you make. And that’s especially true when it comes to IPOs where information on the company can be limited.

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Remember, investing in an individual company isn't right for everyone because if that company fails, you could lose your whole investment. If you cannot afford this, investing in a single company might not be right for you. You should make sure you understand the companies you're investing in and their specific risks. You should also make sure any shares you own are part of a diversified portfolio.

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All you'll need to do is review your investments regularly to make sure they still meet your needs and objectives.

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