Why Initial Public Offerings Can Be Risky

Investing in an initial public offering (IPO) can be an exciting thing for investors. But, it’s worth noting that investing in IPOs may be risker than investing in stocks that already have a long listing history.

As my colleague Ser Jing had pointed out back in December 2014, “roughly two-thirds of local shares are now [referring to 13 December 2014] likely to be lower than their IPO prices.”

Here are some possible factors that can increase the risks of investing in IPOs.

Management selling out

I have heard of investors who bought into container port owner Hutchison Port Holdings Trust (SGX: NS8U) when it listed, mainly because of its association with Hong Kong billionaire, Li Ka-Shing. The reasoning is that investing in the trust would be like investing alongside Li, who has a reputation for being a great businessman. What can possibly go wrong?

Yet, if you think about it, an IPO is a way for management to sell part of a company. So if existing shareholders of Hutchison Port Holdings – which includes Li – were selling, were investors actually betting with them or against them?

An IPO to reduce debt

Some companies may push for IPOs because it has lots of borrowings and need an infusion of cash to help handle debt-related liabilities.  If that is the case, investing in such a company can be seen as a form of new investors helping old shareholders and the company reduce its financial risks. The new investors might be left with little upside.

Foolish Summary

There have been many IPOs which go on to become great winners in the stock market. But, investors need to realise what can make IPOs risky.

Investors can give a newly-listed company time to prove itself. As time passes, investors can get a better idea of how strong the business really is and gain a better grasp on the management team’s integrity and capability. Investing in the company at that point in time may thus result in lower risks.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Stanley Lim doesn't own shares in any company mentioned.