Hot IPO? Here’s How to Research Like a Pro

When a well-known company announces it’s going public, the flashy headlines can be hard to ignore. But before you decide to buy in, it helps to do some detective work.

An IPO is the first time a private company is offering its shares to the public, so investors can buy and sell them on a stock exchange. Companies often go public to raise money for future plans¹ like expanding to new markets or developing new products.

Because a newly public company has no trading history, researching it can take some extra effort. Here’s where to start.

Inspect Before You Invest: The Prospectus

The most important IPO reference for investors is the stock issuer’s prospectus. A company planning to go public first files a preliminary prospectus – often called a “red herring” because it bears a red-inked message that some information is subject to change² – with securities regulators.

The preliminary prospectus contains much of the information you’ll need to consider the investment opportunity, including an estimated price range per share.

A prospectus typically includes the following information:

• Business operations: What the company does and its plans for growth.
• Financials: Canadian regulators require two years of financial statements, and American regulators require two or three, depending on the size of the company.
• Risk factors: Material risks that could affect the company’s future performance, such as industry volatility, economic factors and market factors.
• Use of proceeds: How the company plans to spend the money it raises, such as research and development, funding expansion into new markets or paying down debt
• Management’s Discussion and Analysis (MD&A): This section is a breakdown of who runs the company and who some of the largest shareholders are, and it’s a chance for management to explain their vision for the company’s future.
• Investor rights: Your legal protections and rights, such as your right to receive the prospectus or withdraw from a purchase

In Canada, you can find prospectuses on SEDAR+, the online system where companies file documents with securities regulators; it’s administered by the Canadian Securities Administrators (CSA). The American equivalent is EDGAR, operated by the U.S. Securities and Exchange Commission (SEC).

Where else to find info on an IPO

The prospectus is packed with information from the issuer’s perspective. Your next research steps could include these sources:

• Stock exchanges: The exchange where the shares will be listed generally publishes information about new listings.
• Brokers: Your brokerage may share details about upcoming new issues it's participating in, including how to submit an indication of interest.
• Media: Financial news outlets often cover larger IPOs, and might include analysts’ views. Just be mindful that news coverage can sometimes add to the hype.
• New filings on SEDAR+: A new preliminary prospectus is often one of the earliest and clearest signs that a company plans to go public.

A few numbers can go a long way

Once you understand the business, consider whether the estimated price range makes sense for the business. Common valuation metrics include:

• Price-to-earnings (P/E) ratio: The proposed divided by earnings per share. It tells you how much investors are willing to pay for each dollar of profit the company generates.
• Price-to-sales (P/S) ratio: The proposed divided by revenue per share. It can be useful for companies that are not yet profitable, which is often the casewith IPOs.
• Price-to-book (P/B) ratio: The company’s market cap compared to what its assets are worth on paper, calculated by dividing the proposed current share price by the book value per share.

To help you asses if a company is fairly priced, you may want to compare these numbers with other competitors and the industry more broadly: Is demand for its product or service growing? Who are the main competitors in the market? What is the company you’re interested in doing differently?

These questions are especially relevant in the artificial intelligence (AI) space, where several high-profile companies have been preparing to go public at eye-popping valuations. Some AI businesses spend extensively on computing power and infrastructure and may not yet be profitable, making P/E ratios less meaningful than other metrics and fundamentals (more on that below). And because the technology is evolving so rapidly, the companies that are competitive now might not be in five or 10 years and vice versa.

Canadian securities regulators have warned about "AI washing", when companies exaggerate claims about their AI to bolster investor interest in an IPO, so look for specifics about how the company actually generates revenue.

More tips before investing in an IPO

• Check registration: To make sure an investment opportunity is legitimate, double check that the advisor or firm selling it to you is registered with the Canadian Securities Administrators’ National Registration Search. Investment advisors and firms are required to register with the securities regulator in their province or territory of business.
• Be cautious of scams: Fraudsters sometimes offer “exclusive access” to pre-IPO shares through cold calls, social media DMs or WhatsApp messages. Beware of messaging that plays on urgency and scarcity. Sticking to a platform you know is legitimate can also help you avoid scams.
• Know you may not get shares: Demand for shares of popular IPOs can exceed the number of shares available in the market – this is known as an “oversubscribed IPO.” If this happens, your order may be only partially filled or not filled at all.
• Understand lock-up dates: Usually, insiders such as founders, large shareholders, executives and early investors are not allowed to sell their shares for a set period, also known as a lock-up period. When the lock-up period ends, a large number of shares may become available for sale all at once, which could create downward pressure on the stock price. Keep those dates on your radar.
• Look past the hype: Focus on company fundamentals – factors such as earnings, revenue, cash flow and risk – that determine its financial health, not just hype or speculation for its products or brand.

IPOs in perspective

IPOs can be volatile. On the first day of trading, share prices may jump, or they may fall below the offering price, and the volatility can persist for months before the stock stabilizes. Before investing, consider your time horizon, your risk tolerance and how an IPO would fit into your long-term investment strategy, including whether it would leave your portfolio overly concentrated in one industry or company.