13 May 2022
An IPO valuation is an approach where analysts determine the fair value of a company’s shares. On the other hand, an IPO (initial public offering) is when a privately owned entity changes into a general firm whose shares trade on the stock exchange or capital market. Once a private company transforms into a public company, it becomes the property of the shareholders who buy its stock. Read on to understand IPO valuation extensively.
As we have learned above, an IPO valuation is the idea where Wall Street financial experts determine the fair value of an organization’s shares. Two similar firms can have varying IPO valuations due to the pre-IPO’s public market demand and timing.
Organizations go through meticulous preparation and compliance before listing stocks for sale on the New York stock exchange and NASDAQ. Besides providing the public and the SEC (Securities and Exchange Commission) with a comprehensive prospectus on their background, team, possible mergers, and financial metrics, they have to propose a starting price for each share they sell in the biggest IPO market. The price generates an IPO valuation for the organization.
Many investors who participate in the IPO process do not understand how an organization’s value is determined. Before issuing stock to the public for the first time, an investment bank is appointed to establish the value of the organization and its shares before they are listed in the venture capital stock market.
Investors can have difficulty evaluating an organization with a newly issued stock that has not been traded before in an exchange market. However, intelligent investors analyze a company’s financial standing and registration documents to determine whether the stock is well priced.
The success of an IPO process depends on the consumer demand for the firm’s shares. When the demand is high, the stock price rises. Other factors that help establish an IPO valuation include dividend growth prospects, industry comparable, and the company’s story.
Worth mentioning is that high demand does not indicate the company is more valuable. Often, a company’s marketing campaigns can overpower its real fundamentals. As a result, early-stage investors should thoroughly review an organization’s financial statements before engaging in the IPO process.
The average valuation of firms in the US before their initial public offering between 2000 and 3030 was more than $265 million. However, this amount rose to more than $570 million for the same organizations in 2020.
To calculate IPO valuation, investment bankers collect all data and review the financials of an organization, its liabilities and assets, market performance, and revenue generation. This data is thoroughly evaluated over a particular period before its submission for an official audit. A prospectus is then filed based on the audit with the relevant stock exchange, an offering date is set up, and the IPO price is determined. Some factors that affect IPO valuation include:
There are various IPO valuation methods that investors should beware of. Regulatory bodies usually study and evaluate each IPO application to make sure the money the general public invests will be in safe hands. These valuation methods include:
Under the relative valuation, the value of a company’s share is established by determining the value of similar organizations. This valuation method requires the experts to monitor their competitors. Relative valuation is also referred to as the comparable valuation method.
The absolute valuation method helps measure a specific company’s financial status and strength. It uses DCF (Discounted Cash Flow) in evaluating the company’s wealth. However, the absolute valuation method differs from relative valuation because the former analyzes the organization’s wealth through interest collection and the time money value. On the other hand, relative valuation calculates an organization’s wealth by comparing its competitor’s wealth.
The discounted cash-based valuation is the approach where experts converge and evaluate expected cash flows, investment, performance, and potential revenue sources. This method can be time and energy-intensive. Further, investors need to understand it comprehensively, seeing that the evaluations are done on the business performance, which must be appropriate.
An economic valuation is a mathematical approach where different parameters are considered. These parameters comprise debts that need to be cleared, businesses’ residual income, risk-bearing possibility, assets owned, and liabilities to relieve.
The price-to-earnings multiple approach values an organization that determines its current share price about its earnings per share. Analysts and investors use price to earnings multiple valuations to find the relative value of an organization’s claims.
This method can also come in handy to compare an organization against its historical record or aggregate markets against each other over time. To determine a company’s true value, divide the actual value by the net income to establish the valuation multiples.
Going public through an Initial Public Offering (IPO) can be an exciting step for a company, but it’s not without its share of risks and challenges, especially when it comes to valuation. Here are some key considerations:
The stock market can be highly volatile. IPO valuations can be influenced by market sentiment, which can change rapidly. Companies must navigate this uncertainty to ensure they don’t price their shares too high or too low.
Different industries have unique challenges. For example, tech companies often face valuation challenges due to the intangible nature of their assets, while traditional manufacturing companies may be subject to cyclical economic factors.
Economic conditions can significantly impact IPO valuations. A strong economy can create favorable conditions for higher valuations, while a recession can dampen investor appetite and lower valuations.
Companies must adhere to strict regulatory requirements when going public. Failure to comply with these regulations can lead to legal issues, fines, and even the cancellation of the IPO.
Timing is crucial in IPOs. Choosing the right moment to go public can be tricky. A market downturn or unfavorable economic conditions can negatively affect valuations.
Navigating these risks and challenges in IPO valuation requires careful planning, market analysis, and sometimes, the assistance of financial experts and underwriters. Companies and investors should approach IPOs with a clear understanding of these factors to make informed decisions and mitigate potential risks.
Private companies seeking to raise capital by issuing securities can do so through private or public placement. Publicly traded securities are more subject to rigid regulations than privately traded securities. While both IPO and private valuation provide the relevant capital, the method of issuing current financial reports and the availability to investors is different with every issue. Here is how an IPO valuation differs from a private valuation.
A private valuation issuer can sell complex securities to authorized investors who know the potential rewards and risks. Doing so allows the organization to maintain private ownership, eliminating the need to file yearly disclosures with the securities exchange commission.
IPOs can be risky for investors because they lack previous market activity. As a result, reading the IPO valuation prospectus report and understanding the company before investing is critical.
Promoting an issue can be complex for private valuations because these investments are usually risky and have lower liquidity than public valuations. The execution of private valuations is also faster than IPOs; private companies don’t have to compromise their privacy to access cash or liquidity from a deal.
IPO shares of a firm are priced by underwriting due diligence. Once a company becomes public property, the previous privately owned shares become publicly owned, and the current private shareholder’s shares convert to the public trading price.
A model IPO valuation features three managing underwriters who jointly earn 7% of the total proceeds raised. As a result, the offering size should be $200 million if the numbers are to work. Organizations are afraid of incurring over 15% dilution from an offering, leading the minimum IPO valuation for a company to be a minimum of $1 billion. Depending on the prevailing market or revenue value ratios, a firm should generate up to $200 million in annual revenue to justify a $1 billion valuation.
The new issue IPO is the initial sale of shares by a firm to the public. Here are tips to help you tell a good IPO from a bad one.
The most common method of analyzing an IPO is via peer valuation. Comparing the price of an IPO with the share price of its peers trading in the market can help you understand whether a new offer is undervalued or overvalued.
Investors should compare crucial ratios like the operating margin and book value of the IPO issuing firm with those of other market organizations listed on the market capitalization exchange.
Suppose the firm displays solid fundamentals; you should compare the cost of the IPO with the earnings projections and history. Comparing earnings multiples helps you determine whether the firm is overvalued or undervalued.
Flipping is the idea of reselling an IPO share in the first days to earn a quick profit. While institutional investors can make huge sums of money from flipping, new investors should avoid it. Previously, many IPOs that made massive gains on the first day of listing dropped after institutional investors reserved their profits.
Investors looking forward to making short-term gains should invest in new offers once the markets turn bullish. Remember, volatility is one factor that determines the success of an IPO at the listing time.
A company that goes public for an IPO presents the RHP (red herring prospectus), displaying the earnings and revenue the firm has generated. Determine whether the firm is growing and making a profit. Read through the company’s financial statements carefully to ensure you make an informed decision.
According to the law, promoters must have at least a 20% post-issue stake. Go through the prospectus and determine the percentage holding for the promoters after the IPO valuation. Always invest in firms where the top management team or supporter has many shares. That can indicate the top management’s stringent belief in the firm’s future growth.
Sometimes IPOs can be over-subscribed by more than two times. Avoid getting excited over it. Many investors think that when an IPO is over-subscribed, it is an excellent investment which is not always the case.
An organization acquires capital to grow through acquisitions from private investors or family members, bank loans, or private equity organizations. Whenever the firm raises new money, new investors are ready to pay more for stakes at the company as long as its performance is good.
If a company offers shares to investors via a public offering, existing shareholders acquire more by disposing of their shares post listing. Even when the share price drops from the IPO, the investors will get more than they had invested. Investors investing in the IPO for the first time may not enjoy the same experience.
The prospectus a company issues indicate how the company plans to use the capital it raises from an IPO. If it intends to use the money for diversification, expansion, or activities touching on the company’s growth, then investing in it would be ideal. However, if the company uses the money to repay a loan or any other activity unrelated to future change, you may want to avoid it.
Here is an example of an upcoming IPO valuation. Before investing in IPOs, allocate a small amount of your portfolio. Avoid investing large amounts of money in a single company even if it has been listed on Nasdaq and the NYSE for years.
The IPO valuation of Stripe is $95 billion, and its expected arrival date is sometimes mid-2022. This payment processing plant based in San Francisco has enjoyed good times. It raised more than $550 million during its last round of funding in 2021, propelling its valuation to more than $90 billion. That amount will make the company one of the largest IPOs in the modern world due to its eCommerce popularity which increased following the pandemic.
An IPO, just like any other investment, comes with various risks. As a result, investors should do their due diligence before investing. Evaluate financial statements and prospectuses to understand the company’s standing and be on the safe side.