Growth & Jobs | The growth of the local stock market - The 101 on IPOs
Given the successful listing of several companies on the Jamaica Stock Exchange in recent years and the general positive performance of the stock exchange, many Jamaican investors have taken an interest in the local stock market.
However, there are many who have thought about investing, but have never done so because of a lack of understanding of the stock exchange and the process of the initial public offering (IPO).
Luwanna Williams, corporate finance manager, JN Fund Managers Limited, explains that the IPO may be viewed as the ‘birth’ of a private company on a public exchange, also known as a stock market.
A company may do an IPO, she says, to increase the number of shareholders in the company in order to gain visibility and/or to raise funds. Williams played a leading role in the Wigton debt placement in December, and has assisted in several IPOs carried out by JN Fund Managers.
“IPOs are done through brokers, which is where a client can access a variety of investment offerings, such as stocks. Investors access the IPO through brokers,” she says.
Leading up to the IPO, Williams says, a company makes a formal offering to investors, called a ‘prospectus,’ which is the blueprint of the business. It is a map, she explains, showing the business model, the financial performance, how much money is being raised, and a profile of who manages the operations of the company.
The prospectus guides the investor as to whether the offer fits their personal needs and interests.
“If participating in an IPO is a marriage, then the prospectus would be the dating process. It may not be a good idea to ‘marry’ prior to ‘dating,’ and, more importantly, not all dates lead to marriage. What may appeal to one investor may not appeal to another, which underscores the importance of the prospectus,” Williams explains.
Quality at a discount: An IPO price is usually below the market price, Williams says, which allows investors to access the company at a lower relative value. The company’s valuation is based on historical and projected profitability, composition of the balance sheet, how demanded are products and services, and the factors influencing the state of the overall economy.
Chance to finally start investing: The JN Fund Managers investment banker says many persons have thought about investing for some time, and the level of publicity around an IPO may lead new investors to finally make the step.
Portfolio benefit: Adding stocks to one’s investment portfolio is a great way to diversify investment holdings and spread risk, Williams points out. Also, by purchasing stocks in different companies across different sectors of the economy, persons can further diversify their portfolio.
Caution … beware of the bounce: Williams says there are cases where persons may use IPOs as an opportunity to realise high returns in a short period. This is based on the fact that the IPO price can rise rapidly soon after being listed on the market.
As investors rush for the shares, the demand drives up the price; however, this spike is unpredictable, thus not guaranteed, and it does not usually last more than a few days, when stocks are established as medium- to long-term investments. As a result, the price can fall sharply shortly after rising rapidly. On those grounds, it is not best to use IPOs as a ticket to “overnight riches,” Williams cautions, but rather to invest with a medium- to long-term horizon in view.
Price volatility: As a stock is traded, it is subject to price movements both ways, up and down. This is yet another reason why stocks are best for medium- to long-term investors, Williams highlights.
IPOs signal confidence in an economy and may attract local and international investors to participate. However, IPOs can be challenging to navigate for new investors, hence the importance to consult with licensed investment professionals to learn more.
Luwanna Williams works with JN Fund Managers, a licensed broker and securities dealer.