What is an IPO (Initial Public Offering)?

An IPO, which stands for Initial Public Offering (in Dutch, a stock market listing), is the process whereby a private company issues shares to the public for the first time on an official stock exchange. From that moment on, anyone can freely trade the shares. Although an IPO is often presented as a unique opportunity, at its core it is simply a moment when the current owners sell part of their company to new investors.

How exactly does an IPO work?

When a company decides to go public, it usually hires large investment banks to guide the process. These banks determine the offer price and go on a so-called roadshow. In practice, this is a large marketing campaign to get institutional investors excited about the company.

The most important thing to remember here is the sales dynamic. In an IPO, the price is determined by the selling party (the current owners and the banks). Their goal is logically to raise as much money as possible and therefore bring the shares to market at the highest possible price. This runs counter to the goal of a value investor, who is precisely looking for a share with a substantial discount relative to intrinsic value.

An IPO in practice

You often recognize the listing of a large company on the stock exchange by the enormous media attention. Think of the IPOs of major tech companies or quick-commerce delivery firms. The newspapers are full of it and retail investors develop FOMO (Fear Of Missing Out): the fear of missing the next big market windfall.

What often happens in practice is that the share price shoots up sharply on the first trading day because of this hype. Investors pay prices that are totally out of proportion to the company's actual profitability. After a few months, when the media attention fades and the first sober quarterly figures are published, reality returns. The overvaluation is harshly punished by the market and the share price collapses. Anyone who joined the hype on day one sees their capital evaporate.

Opportunities and Risks

For most level-headed investors, an IPO carries significantly more risks than opportunities:

• Risk: Large overvaluation. The issue price is usually optimized for the seller, not for you as the buyer. You pay the absolute top price.

• Risk: Lack of history. Because the company is new to the stock market, there is little historical data on how management handles setbacks under the watchful eye of public shareholders.

• Risk: Lock-up periods. Often the founders are not allowed to sell their own shares during the first six months. Once this 'lock-up' expires, insiders dump their shares en masse, which can put significant pressure on the stock price.

• Opportunity: The post-IPO dip. A patient investor waits until the hype around the IPO has completely subsided and the stock is unfairly punished (sometimes years later). Only then might an interesting price emerge.

Mpartners' view

Legendary value investors such as Warren Buffett generally never participate in an IPO, and at Mpartners Vermogensbeheer we fully share that sensible view. Within our philosophy of Value Investing, we look for robust, proven quality companies with a wide margin of safety (safety margin).

In a stock market listing, that margin of safety is virtually never present. It is a market driven by marketing, emotion and promises for the future, rather than by hard, current fundamental value. We protect our clients' wealth by staying away from the issues of the day. We prefer to invest in somewhat 'boring', but predictable and profitable companies that have already proven themselves on the stock exchange long ago. That is the basis for capital preservation.

Would you like to invest based on fundamentals instead of hype and promises? Feel free to contact us for a clear conversation about independent wealth management (from € 300,000) in Amsterdam.