What's the best way to determine whether to invest in a company after its IPO?

Published Sun, Jun 9 202410:00 AM EDT

Here's our Club Mailbag email investingclubmailbag@cnbc.com — so you send your questions directly to Jim Cramer and his team of analysts. We can't offer personal investing advice. We will only consider more general questions about the investment process or stocks in the portfolio or related industries. This week's question: Considering the potential upside (and downside) of IPOs, and the hype that always seems to accompany them, can you please give us fairly new investors some information on how to analyze and value these offerings? Thank you, and thanks for all of your hard work. — Tom in New York Before a private company goes public, it must first send its company and financial information to the Securities and Exchange Commission in an S-1 registration statement. The timeline between filing the form and the actual IPO ranges, but it usually happens between several months and a year. So you have some time to study all the key information for investors, including past financials, management's discussion and analysis of that data, the key metrics management uses to judge the business's performance, and the intended use of proceeds from the IPO. It also contains the actual terms of the offering. Equipped with the company's financial data and an understanding of the business and industry it operates in, we can work on determining a valuation. We approach this the same way we do with a public company by starting with the financial metric on which to basis our valuation, looking at peer valuations in the public market and then making adjustments based on the differences in its financial health, growth rate and other important factors. See our story on making sense of the "multiples approach" to valuing stocks for more detail. To get the appropriate value on a per-share basis, simply divide your market cap result by the amount of shares outstanding, also in the S-1. If there are warrants or restricted stock units (RSUs), you'll need to treat them as if they've been converted to shares — because they may well be in the future — and add to the total share count. The point is to get a per-share value on a fully diluted basis, meaning all the ownership units out there. That way, you have an idea of the value you're really getting now when you buy a share and what it could become in the future should it get diluted as insiders offload shares or exercise options or warrants. Now that you have a valuation, the question becomes: Is it undervalued, fairly valued, or overvalued? Two things to keep in mind when answering: What is the "float," or the percentage of the total shares outstanding that are in the IPO? If the float represents a very low share of total shares outstanding, it means more potential volatility in the stock. The new money is fighting over a small slice of the company, which can lead to wild swings in the price from day to day. A low float also means there is a lot of stock being held back that could get sold later and drag down the stock price. Insiders must usually agree to lockup period for the shares they own that generally lasts anywhere from 90 to 180 days. That means that the whales (big individual investors or firms) sitting on a ton of shares can't sell right away. Why does that matter? Because it means that a ton of supply could hit the market once the lockup ends and tank the stock. The smaller the IPO, or lower the float, the stronger the likelihood of a big swing post-lockup. If we are seeking to determine intrinsic value, the lockup period shouldn't impact our decision on whether the stock is a buy or not. However, a large seller or sellers entering the market certainly impacts the actual supply-demand dynamics of the stock. That means waiting until after the lockup period might mean a more attractive entry price. So our valuation analysis can tell us whether to buy, while our analysis of the float versus total outstanding shares — as well as how many shares may get sold once the lockup ends — can help inform when we may want to buy shares. (See here for a full list of the stocks INJim Cramer's Charitable Trust.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust's portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. THE ABOVE INVESTING CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY , TOGETHER WITH OUR DISCLAIMER . NO FIDUCIARY OBLIGATION OR DUTY EXISTS, OR IS CREATED, BY VIRTUE OF YOUR RECEIPT OF ANY INFORMATION PROVIDED IN CONNECTION WITH THE INVESTING CLUB. NO SPECIFIC OUTCOME OR PROFIT IS GUARANTEED.

Traders gather at the post where Rubrik Inc., the Microsoft backed cybersecurity software startup, is traded during the company’s IPO at the New York Stock Exchange (NYSE) in New York City, U.S., April 25, 2024.

Brendan Mcdermid | Reuters

This week's question: Considering the potential upside (and downside) of IPOs, and the hype that always seems to accompany them, can you please give us fairly new investors some information on how to analyze and value these offerings? Thank you, and thanks for all of your hard work. — Tom in New York