How IPOs Work: What Investors Should Know Before Buying a New Stock

An initial public offering (IPO) is the first time a private company sells shares to the public and lists them on an exchange such as the NYSE or Nasdaq. IPOs generate excitement and headlines, but they come with unique risks.

How the IPO Process Works

1. Choosing underwriters. Investment banks help set the price and sell the shares.
2. Filing an S-1. The company files a registration statement with the SEC disclosing its business, financials and risks. You can read it on SEC EDGAR.
3. The roadshow. Management pitches the company to institutional investors.
4. Pricing. The night before trading, the IPO price is set based on demand.
5. First trade. Shares begin trading on the exchange, often at a very different price from the IPO price.

Risks of Buying IPOs

• Limited history: Fewer years of public financial data to analyze.
• Initial allocations go mostly to institutions: Retail investors often buy after the first-day "pop."
• Lock-up expirations: Insiders are typically restricted from selling for a period (often around six months). When that ends, extra supply can pressure the price.
• Hype: Popular IPOs can be priced for perfection.

A Smarter Approach

Many experienced investors wait a few quarters after an IPO to see how the company performs as a public company. Read the S-1, review the income statement and apply our stock analysis checklist.