The Risks of Initial Public Offering Stocks

Getting involved with an initial public offering can be promising. Sometimes the immediate returns are substantial. Yet although this type of stock is very popular, there are definitely some risks involved when investing. Here are some of the risks of getting involved with initial public offering stocks.

Initial Public Offering Stocks

An initial public offering is when a private company first issues stock to the public. This is also referred to as "going public." In many cases, companies that have gone public have generated substantial returns within only a few days. Many times, on the first day of the company's going public, the stock price increases in value by two or three times. This happens because there are more investors that want to get involved in the stock than there are shares of stock. When this occurs, the price of the stock will shoot up drastically.

Share the Risks of the Company

Even though this type of investment can sometimes be extremely profitable, you have to be aware of some risks as well. In fact, when you are investing in a company that is going public for the first time, you are essentially sharing some of the risk with the company. You are putting money into a company that has not yet been established. If the company does not perform well, you could lose all of your investment.

Lack of Information

Another potential problem with investing in initial public offerings stocks is that they have a lack of information surrounding them. When a company is going public for the first time, they have to provide documentation to the Securities and Exchange Commission (SEC). They also have a prospectus that you can read as an investor. However, compared to the information that you have on an established company, this is not very much to go off of. You are essentially going off of hype and what other people are saying about a company instead of the fundamentals. Part of the process of investing in an initial public offering is hoping that you get lucky and choose the right company.

Long Holding Period

When you invest in an initial public offering, you hope that the stock price goes up significantly within the first few days of its being available on the market. However, sometimes this is not the case. You might have to hold onto your stock for quite a while before you can realize a profit. For every initial public offering that increases rapidly the first day, there are many more that do nothing. At that point, you are essentially investing as if in any other company and hoping that they perform well over the long term. The only problem with this scenario is that you are investing in a company that you know very little about. Over the long term, this company could perform poorly, possibly costing you your entire initial investment. 

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