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Q: I’ve been reading about the Airbnb IPO, and it sounds like a profitable opportunity. What is an IPO and why would I want to invest in one? And how much should I invest?

-- A prospective IPO investor

I totally understand your interest. There has been a lot of media buzz and hype this year about some high-profile companies offering shares to the public for the first time. This has definitely sparked the interest – and curiosity – of investors.

First off, IPO refers to Initial Public Offering. It is one of the ways a privately held company can become a public one and get listed on a stock exchange. A company may want to do this so that it can raise capital, funds that could be used to fuel future growth.

Before a company is listed, it will issue shares in exchange for a set price (also known as a primary sale or offering). This offering is typically only available through a broker and allows you to purchase these shares before they are listed on the regular stock market. Consider it a way of being first in line to buy shares of a company before everyone else. Once the primary sale has been completed, the shares become available to buy on the secondary market. At that point, anyone will be able to buy and sell shares of that company.

For some investors, the thought of snagging a stock as soon as it becomes available is an enticing proposition. It’s a way of getting in on the ground floor. But, with any stock, even a new one with a recognizable name, there is no guarantee that it will perform well in the future. That underscores the importance of taking the time to do your homework before you click ‘buy.’

Here’s what you need to do. Before a company’s IPO, it will release an “S1” (if it’s a U.S. company) or “prospectus” (if it’s a Canadian one). These are public documents filed to a regulator listing the company’s pertinent financial information. Get your hands on these and give them a thorough read. These docs are a great place to start to find out more about a company you are considering investing in when it’s about to go public. You’ll want to find out what the company does, how it operates, who owns it, what competition and challenges it faces in its sector, and how well, or not, it has performed so far.

After you digest all that information, ask yourself how you feel about the company’s short- or long-term prospects. Is the company growing? Is it making money or struggling? Naturally, this type of research is not limited to IPOs that you’re considering buying. Doing your due diligence is something you should undertake with any investment you make.

It’s impossible to tell you exactly how much you should invest in an IPO. It depends on so many factors specific to you – your risk tolerance, investment goals, available funds, etc. Do remember that most brokers require you to invest a minimum amount to purchase an IPO. For example, Questrade allows investors to buy Canadian IPOs during their primary offering with a minimum investment of $5,000, so keep that number in mind as an entry point.

IPOs, like any investment product, are best used as part of a diversified portfolio. They can be held in any type of investment account (RRSP or TFSA, etc.). Before you make your IPO purchase, understand that not all brokers are made equal. Look for an online brokerage that offers free dual currency accounts (so you can hold both Canadian and U.S. dollars in the account and avoid unnecessary currency conversion fees), no account opening or closing fees, and no withdrawal fees.

If you’re keen to invest in IPOs, you’ll need to stay up-to-date on what companies are offering them. Watch for IPO announcements on financial websites, or refer to the designated IPO section on websites for NASDAQ and NYSE. On the TSX website, you can find a section dedicated to new company listings. Also consider signing up for the free IPO Bulletin from Questrade, handy for keeping you in the loop.

Scarlett Swain is Director, Investment Products, Questrade. Based in Toronto, she joined the company in May 2018. She has more than 20 years of experience in the financial sector.

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Article comments

1 comment
Pmcnamars says:

Very informative and I will keep this in mind in the future