Booyah Breakdown: ABCs of IPOs

Keep in mind, most of us had a better shot at getting an invite to the Tom Cruise-Katie Holmes Italian wedding extravaganza then attending a road show. The typical road show guest list consists of institutional investors or folks willing to buy big chunks of the stock.

Once the bankers, a.k.a. the underwriters, believe they have enough interest to sell the stock, they attempt to set a reasonable price based on level of interest. And as long as the company agrees to the suggested pricing, an underwriting agreement is signed, a final prospectus is created for potential investors, and then it's off to the races.

Now you could just wait until the stock is available on the open market and invest at that point. But here's the rub: The stock could jump on the first day of trading, so it would be nice if you could take advantage of that bounce by buying shares at the offering price. But, again, getting IPO shares is tough. They are generally reserved for the people in the inside.

Jumping on for the Ride

First decide if you even want the company in your portfolio. Educate yourself in the market space, and read the prospectus of the IPO you've selected. Determine what the company plans to do with its new financing. Is it simply going public to pay off some debt? Or is it using the money to reinvest in the company and help it grow? Use of proceeds is a good indicator for whether you want to invest.