IPOs are an important opportunity. Here's how to invest in them. 

An IPO is a win-win situation

Stadler Rail, Galenica, Facebook, and Alibaba have all gone for an IPO in recent years. Although not all IPOs attract such high levels of interest among the public, all companies floating on the stock market have one thing in common: They are seeking a listing on the stock exchange in order to raise new capital from a broad base of investors.

Fresh capital enables companies to grow, and to strengthen their equity capital. However, an IPO is an attractive prospect for investors too: Not only are they involved from day one, but the value of the new shares often climbs faster than the total market within a short time. That makes it possible to generate respectable returns in some cases.

Private investors buy shares via client advisors

Extensive preparatory work is undertaken behind the scenes in the run-up to the public announcement of an IPO. This also includes holding discussions with potential institutional investors, who are the main investors in an IPO. Only if going to the stock market looks promising does the plan ever reach the public.

But anyone wanting to be successfully involved in an IPO needs to act quickly. Fact is, there are only a few weeks from official public announcement to the IPO itself. "Private investors should therefore contact their client advisors and express their interest at an early stage," says Philippe Lutz. Lutz is responsible for coordinating the distribution of capital market transactions within the Private Banking division of Credit Suisse. Interested parties then receive the IPO prospectus and information about the price range as soon as the documents become available. This information enables them to make a qualified assessment as to whether the IPO offers a worthwhile investment.

IPOs are usually oversubscribed

IPOs often attract high levels of demand, and are usually oversubscribed. In other words, demand for the shares among potential buyers is greater than the number of shares coming onto the market. Depending on the extent to which an IPO is oversubscribed, investors receive a smaller or larger percentage of the shares they want. However, no-one knows this until the very last minute.

Those who decide quickly and place an order via their client advisor can be at an advantage: "Subscriptions on the first few days are valuable for a company. They show that the shares are sought-after, and this can have a signaling effect," says Philippe Lutz. A company may therefore decide to give such buyers preferential treatment, whereby they receive slightly more shares than interested parties who come along later.

Opportunities and risks of an IPO

The price of the new shares should always be somewhat lower than the fair valuation, since it is this IPO discount that makes the IPO attractive to investors. This ultimately makes it more likely that the price will rise. Added to that, a high degree of oversubscription indicates that the shares are in demand and that upside potential exists.

However, there is no guarantee that the price will actually rise despite the lower issue price. It is possible that market demand for the shares will be lower than anticipated. There may also be a general deterioration in investor sentiment. "From personal observation, I would say that IPO shares are usually more volatile than the market as a whole," says Philippe Lutz. That means they fall more sharply in the event of a market correction, but also rise more quickly in a positive market environment.

Emotional factors play a role in an IPO

Private investors should not ignore the cluster risk either. If you have limited capital, exposure to individual equities is usually not a good idea. Investment funds offer better diversification. "Personally, I would only advise taking part in an IPO if you have capital of at least one million Swiss francs," says Philippe Lutz. However, he does recognize the importance of the emotional factor – even in the case of a smaller budget. "Stadler Rail was understandably very popular with private individuals."