• Today, as part of the "Calculate and don't miscalculate" campaign, we explain what investing in IPOs, or initial public offerings, is all about.
• Before you decide to invest your savings in an IPO company, check its business strategy and the risks involved.
• Remember that in the stock market you can not only gain but also lose. IPOs are especially often advertised as sensational opportunities to make money, but the reality rarely keeps up with the promises.

As the campaign of the President of UOKiK "Calculate it and don't miscalculate" continues, we are giving out advice on what to look out for when investing in various financial instruments. Among numerous possibilities, a particularly popular one - in Poland for more than a quarter of a century, i.e. at the beginning of the political transformation - is investing in stock market debuts, the so-called "IPOs" initial public offerings.

How a public offering works

Initial public offering, or so-called "IPO,"  is a debut of a joint-stock company on a public stock exchange - in Poland on the Warsaw Stock Exchange. Nowadays, typically such a company was previously listed on an alternative market for professionals, where less restrictive regulations apply. Going public means that virtually anyone can become a shareholder in the company, derive income from its activities and even - although in the case of an individual investor this is a rather theoretical possibility - influence the company's policy by voting at its general meeting of shareholders.

Buying shares of a debuting company is technically and practically different from buying shares of a company that has already been listed. In the latter case, there is a buying and selling transaction between two parties at a price that is the product of the market play of demand and sale. In contrast, in a public offering, the debut price of the stock is set by the seller based on initial investor interest. A phenomenon typical of public offerings is the so-called reduction - demand for shares of the debuting company exceeds supply many times and eventually, each buyer gets not as much as he signed up for but proportionally much less. For example, if the debut offer includes one million shares at one hundred PLN each (one hundred million in total), and buyers have collectively declared their intention to purchase shares for five hundred million, the reduction will be 80 percent and everyone only gets one-fifth of what they signed up for. In extreme cases, the reductions reach as high as 97 percent, which means that a person signing up for three hundred shares gets only ten. Investors are well aware of this, so they often sign up in advance for a much larger number of shares than they actually intend to own - but there is an additional cost here, as you have to put up the funds for the number of shares you have declared your intention to buy. As a result, some investors take out short-term loans for this very purpose.

When buying shares of listed companies, we can trace their history: publicly traded companies are required to publish detailed financial reports on a regular basis, and they are often well-recognized companies from which we know more or less "what to expect".

- A stock exchange debut sometimes resembles an advertisement in a job-seeking portal or even a dating site - the company's strengths are exposed, while the prospects of market success are sometimes really exaggerated. Companies very often pick the moment for the debut based on upcoming promising events, e.g. some time after releasing a new computer game that received great reviews, or after receiving a patent for a "breakthrough" technological process. Debuts of new technology companies have been particularly spectacular as well as recent debuts of developers or companies connected with private health care - says Tomasz Chróstny, President of UOKiK and emphasizes: - An investor must remember that the market can be fickle and fame is fleeting - it is not easy to repeat the box office success of a digital production, and a new, supposedly unique, technology is only a vague promise, not a guarantee of profits.

Beware of inflated valuations

In the case of IPOs, it is particularly important to emphasize that there are no "profitable per se" investments in the stock market - that profitability is always relative. Companies going public must have their prospectus submitted and approved by the financial supervisory authority (in Poland the UKNF), which verifies their financial standing, capital and managers' warranty - so they are not secretive or "shady" businesses like financial pyramids. Nevertheless, there is no guarantee that the stock price at the time of the debut reflects the correct prospects of the debuting company. In other words, even for a pretty solid product, it's also possible to overpay. Here comes another factor to watch out for when planning to subscribe to shares of a debuting company, namely the practice of valuing the debuting company's shares above a reasonable level based on the company's financial condition and market position, and thus its real, market value. We refer to a debut in which IPO share offerings appear particularly inflated as an aggressive IPO, and we refer to the practice of telling the public that what is priced is adequate and reflects the rookie's excellent prospects as window dressing. Window dressing can involve the use of standard and modern channels for aggressive marketing and often accompanied by the so-called creative accounting, in which the condition of the company in the financial statements is presented in a better light than it really is.

- The consequence of an aggressive IPO is usually that the IPO cannot live up to expectations. Not only does it not show profits higher than other listed companies, but sometimes it even brings losses to the investors - says Tomasz Chróstny, President of the UOKiK.  

Investor disappointment has sometimes been as painful as it has been swift - for example, the price of one of the new technology companies that debuted at the beginning of the year fell by more than 20 percent within just two weeks of its debut and never recovered for the next six months. Surveys of companies on the WSE indicated that companies using aggressive IPOs were profitable by as much as 8 percent less per annum (which can translate into a loss of tens of percent of the investment's value over several years) than companies with more conservative issuance policies^[1]. Highlighting high profitability before the IPO is a very popular practice but extraordinary profits do not last forever, hence higher reported profit declared one and three years before the IPO rather than one and three years after the IPO is a rule rather than an exception^[2]. In the Chinese market, it was standard practice for banks to show profitability higher than previously listed banks before listing, but after listing they very quickly equaled the profitability of the others^[3].

Invest in what you understand

The world's most famous investor, Warren Buffet, stresses that you shouldn't invest in industries that you don't understand - if, for example, you don't have any understanding of the computer games market at all, you might be better off not buying shares in a gaming company just because there's a buzz about it and a neighbour of yours has already signed up.

It is also important to realise that those investing in initial public offerings are particularly vulnerable to a psychological trap called the disposition fallacy. The fallacy is that investors tend to prematurely sell companies that have a good track record and are profitable, while holding on to companies that are falling in value and only getting rid of them when the market panics and prices hit bottom. An unsuccessful IPO sometimes means having to accept a small loss to avoid a big loss, which is especially difficult for an individual investor.

About the campaign organised by the President of UOKiK

The aim of the "Calculate and don’t miscalculate" campaign organised is to increase consumer awareness and safety. The President of UOKiK draws public attention to the risk of losing savings and the need to be wary while making investment decisions. From 6 September, spots related to the campaign have been appearing on TV and radio. So far, approx. 180 media and institutions has joined the campaign.

– I strongly encourage entities to continue getting involved in the "Calculate and don’t miscalculate!" campaign. Together, we can reach even more consumers - to warn them, explain and prevent financial losses. I am absolutely certain that thanks to the synergy of actions the awareness of consumers and their safety are increased - says Tomasz Chróstny, the President of UOKiK.

The spots used for the "Calculate and don’t miscalculate" educational campaign are available on the website of the Office of Competition and Consumer Protection.

Consumer assistance:

Tel. 801 440 220 or 22 290 89 16 – Consumer Hotline
E-mail: [SCODE]cG9yYWR5QGRsYWtvbnN1bWVudG93LnBs[ECODE]
 Consumer Ombudsmen – in your town or district

Additional information for the media:

UOKiK Press Office
Pl. Powstańców Warszawy 1, 00-950 Warszawa, Poland
Phone +48 695 902 088, +48 22 55 60 246
E-mail: [SCODE]Yml1cm9wcmFzb3dlQHVva2lrLmdvdi5wbA==[ECODE]
Twitter: @UOKiKgovPL