The process of selling shares in a new company to the public for the first time is called an initial public offering (IPO). What happens to a stock price in an IPO depends on several factors such as the underwriting process, market conditions and investor sentiment.
A company that wants to go public hires an underwriter -- an investment bank that takes it through the process. Part of the process is gauging investor interest, structuring the offering and setting the initial, or subscription, price -- the price at which the stock will be released to the IPO investors (called IPO subscribers) before it starts trading on the open market. The quality of the underwriting greatly affects the stock price when IPO shares open for trading.
IPO Share Pricing and Release
A company releases shares to the IPO subscribers at the price set by the underwriter. Once a stock is released, it starts trading on the open market and its price is set by supply and demand. A stock can rise above or drop below the subscription price. A good underwriter would try to price an IPO to raise the most money for the company but ensure that the stock price rises above the subscription price in the open market. A company typically sells a small number of shares in an IPO and waits for the market price to be established before selling more stock. The higher the stock price goes, the more money a company can raise by selling more shares later.
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IPO Stock Trading
The price of IPO shares in the open market depends on a company’s prospects, investor sentiment and current market conditions. If investors feel excited about an IPO’s prospects, they are likely to bid up the stock price and demand for the shares will exceed supply. If, on the other hand, investors are lukewarm towards an offering, or if general market conditions are poor, an IPO share price may decline as initial investors scramble to unload their shares to cut losses while there are few new buyers.
Basing and Trends
Shares of an IPO may change hands several times as buyers and sellers adjust their positions. Every IPO differs in size and has different owners, insiders, history and prospects. Investor sentiment may change with market conditions and incoming information, including company earnings. Insiders usually cannot sell their shares for the first six months -- a period called a “lockup” -- but after the lockup expires, a flood of insider selling may push the stock price down. For all these reasons, many IPO shares trade erratically for the first six to nine months. This is called basing. Once a more stable and permanent balance is established between buyers and sellers, a stock will move out of its initial base -- up or down. Most IPOs eventually lose value or remain mediocre performers, but some “hot” IPOs become huge market winners.
- SEC: Initial Public Offerings, Pricing Differences
- SEC: Initial Public Offerings, Lockup Agreements
- “PassTrak Series 7: General Securities Representative License Exam”; Dearborn Financial Services; 2003
- “How to Make Money in Stocks”; William O’Neil; 2009