How to Read an IPO Prospectus

The first IPO prospectus draft used before all financial detals are disclosed is dubbed a red herring.

The first IPO prospectus draft used before all financial detals are disclosed is dubbed a red herring.

A prospectus for an initial public offering can be an overwhelming document, given the hundreds of pages of material it usually presents. It's a useful document, however, because it provides a glimpse into a potential investment that most likely -- considering the quiet existence that most private companies enjoy -- you've known little about leading up to the regulatory filing. A prospectus is organized so that you can focus on the content that's most relevant to you, whether it's financial performance leading up to the new issue or the number of individuals employed at the company.

Basics

Scroll down to the part of the prospectus that provides an introduction about the company. Before you even consider investing in an IPO, you should understand the company's operations and the way that it makes money, according to investment expert Warren Buffett.

Look close to the top of the prospectus to learn the stock exchange on which the company intends to list its shares. You should be able to identify either the Nasdaq or the New York Stock Exchange Euronext. If you don't see either of these major exchanges, the company may be listing its shares in the Over The Counter Bulletin Board (OTC:BB) market, which is a less regulated market.

Locate the "proposed offering" size, which will describe the amount of money the company plans to raise. This information should be included in a box graphic in the top portion of the prospectus. Even if you can't learn the exact price per share right away, you should at least be able to get a sense of how big the overall deal will be.

Risks

Read about the competitive landscape for the company under the section titled "risks." You can glean from the document the precise names of the companies that the new issue considers a threat.

Compare the competitive position of the new issue with the company's rivals. It's not unusual for companies to provide data about the size of the market in which they operate and to disclose their market position in a prospectus. Once you learn who the competitors are, research those companies to identify the market leaders.

Look for any red flags about the business, including any legal trouble the company may be involved in, which should be listed under the "risk factors" section of a prospectus. The company should also provide a sense of the monetary toll that legal actions can have on the business.

Financials

View financial tables that disclose recent performance. When Internet company Facebook filed its IPO prospectus, potential investors had some gauge from which to compare revenues because financial performance information was accidentally disclosed elsewhere, according to a 2012 Market Watch article. At the very least, you should be able to see revenues produced over the past few years.

Categorize the various business channels from which the company generates its revenue. This information should be spelled out plainly in the document. You should be able to identify the sources of the bulk of revenues so you can recognize the company's core businesses.

Find out if the company is profitable. This information should be available in the financial table and there should be details of net income. If the company has not yet achieved profitability, there should be some description of when the business is expected to begin earning profits.

Tips

  • The final financial details in an IPO prospectus won't be available until the last minute. Check back with the regulatory filing, also known as a Registration Statement on Form S-1, until all of the pricing details are disclosed.
  • IPO prospectuses are first made available on the U.S. Securities and Exchange Commission website, but they eventually should be available in the investor relations section on the website of the IPO company.

Warnings

  • It can be difficult for the average investor to obtain IPO shares.
  • Even if you perform all of your research and thoroughly examine a prospectus, there's still always a possibility of financial loss when investing.
 

About the Author

Geri Terzo is a business writer with more than 15 years of experience on Wall Street. Throughout her career, she has contributed to the two major cable business networks in segment production and chief-booking capacities and has reported for several major trade publications including "IDD Magazine," "Infrastructure Investor" and MandateWire of the "Financial Times." She works as a journalist who has contributed to The Motley Fool and InvestorPlace. Terzo is a graduate of Campbell University, where she earned a Bachelor of Arts in mass communication.

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