An Initial Public Offering or IPO marks the debut of a company in the stock market. It has now made the transition from private ownership to public ownership. This process of public enlistment means that it is now able to raise capital by selling shares of its company to institutional and retail investors.
From the perspective of a typical investor, participating in an IPO is a highly speculative play. The lack of historical reference makes it hard to gauge if the IPO price sits well with the investing public. However, there are signals that can be used as initial guidelines if an IPO has the potential to perform well in the short term.
In this post, we will be analyzing the key factors that affect the price action of IPOs so that you will be able to make better judgement if the next one is worth your while.
1. General Market Climate
The overall performance of the index is a strong barometer to gauge market sentiment. Remember, prices go up when there are more buyers than sellers and it goes down when there are more sellers than buyers. As such, determine first the status of the current market trend and check if it is shows healthy conditions for IPO issuance.
Bullish market conditions wherein the PSEI is above the MA200 line and near 52 week highs encourage aggressive institutional buying. Inversely, bearish market conditions that shift the index below the MA200 line and near 52 week lows will trigger sustained institutional selling.
In the following data, we will show how historical index performance influenced the price action of IPOs for that year.
2014 - 2015 PSEI Bull Rally
The 2014 bull rally was one of the more notable rallies that have happened after the 2008 market crash. This strong momentum based rally resulted to a 40% return in less than a year. IPO offerings during this period showed substantial gains as appetite for speculative investments were high throughout the course of the rally.
DD: 1 year performance from IPO date
CNPF: 1 year performance from IPO date
SSI: 1 year performance from IPO date
X: 1 year performance from IPO date
Most of the IPOs of 2014 showed strong momentum resulting to very profitable rallies. This is what you get when you have aggressive institutional buying. If you find yourself in such a market condition, subscribing to an IPO maybe considered as a good short term investment.
2019 - 2020 PSEI Market Crash
The duration of 2019 was a year-long sideways move in between the 8200 resistance and 7500 support. This pattern broke down when the pandemic crisis triggered a massive panic selling across the global market. PSEI in particular went as low as -45% where it initially bottomed out near the 2011 key support of 4000. IPO offerings during this time resulted to sustained institutional selling. Only IPOs with small market capitalization made short term rallies.
KPPI: 1 year performance from IPO date
AXLM: 1 year performance from IPO date
HOME: 1 year performance from IPO date
FRUIT: 1 year performance from IPO date
IPOs of stocks that have market capitalization below 3 billion showed initial spikes in the short term. However, IPOs of stocks with market capitalization above 5 billion showed steep sell offs with high selling volume. Looking at this data, we can analyze that subscribing to an IPO during bearish market conditions may not be a good idea. If there is no institutional buying, price action will often result to profit taking and sustained downtrends.
Remember to look at the general market climate first when assessing the potential of an IPO.
Bullish market conditions encourage investors to be aggressive. IPO plays during a strong index uptrend tend to make strong and sustainable rallies. On the other side, bearish market conditions cause investors to sit on the sidelines and be more cautious in participating in speculative plays. IPOs during this time will often result to a selloff. When there is not enough institutional buying, prices will continue to fall until the general market show positive signals.
2. Market Capitalization
Market capitalization refers to the total market value of the company's outstanding shares. Simply put, it tells you how heavy or light a stock is.
Stocks with low market capitalization are very easy to manipulate. Big financial institutions can brute force the price to any direction they want. As such, IPOs of low market cap stocks are prone to price manipulation and volatile swings. Traders can leverage this volatility to score quick gains.
Stocks with high market capitalization are substantially harder to move. This is because of the high volume of outstanding shares that are needed to be bought and sold consistently in order to move the price action to a certain direction. It will often take several big financial institutions to move the price of heavyweight stocks. As such, movement is contracted and less volatile. If there is no demand for the stock, the price will usually shift to a downtrend until buying interest picks up.
3. Fundamentals and News
Since there is no historical data available to gauge an IPO, analysts will focus on company fundamentals to justify its value. Earnings are scrutinized as well as company assets and liabilities. The demand for the sector it belongs to is also taken into account.
News is also a contributing factor to market sentiment. IPOs with interesting stories behind them may attract demand in the short term. This however, is not a concrete basis to construct your decisions on. Regardless of the news, remember that it is institutional buying that will drive the price of an IPO upwards.
The Bottom Line
IPOs are very speculative plays. Most investors who blindly buy them are exposing their hard earned money to unpredictable volatile swings. It is best to allow a stock to form a pattern first and show the underlying market sentiment before you make your move. For the most part, it is best to stay away from IPOs if you have not done sufficient research. Never gamble your money on speculation if the odds do not stack to your favor.
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