E32: What Does Buying Shares in an IPO Actually Mean?
You may have seen people talking about Dangote Refinery’s IPO over the past few days. Some people are excited about it. Others are sharing their concerns.
But before deciding what to do, I believe there is something more important: Understand what an IPO actually is.
As a Personal Development and Finance Advocate, I’m a strong advocate for understanding the basics before taking action.
Because beyond Dangote, understanding IPOs gives you knowledge you can use whenever another company offers shares to the public.
This is Episode 32 of What This Finance News Means for Ghanaians 🇬🇭, where I break down finance news and then share my thoughts in a simple and practical way.
When a company wants to raise money to grow or expand its business, two common ways it can do this are through debt or equity.
IPOs are directly connected to the “equity” side of how companies raise money and expand.
When a company offers its shares to the public for the first time, that's an IPO, hence the name Initial Public Offering. Before an IPO, a company is considered private hence it moves from being a private company to a public company.
Anytime a company sells equity, the company is literally saying: “Investors, give us money and, in exchange, you will own a small piece of our company.”
The company gets cash, and the investors receive shares.(Think of it like having a slice of a full box of pizza but in this case a part of the company)
Life is full of risks so IPOs also come with risks that can be different from buying established public stocks.
As a quantitative risk analysis and management student at Georgia State University, I found it helpful to highlight the risks you should consider.
For example, some of the main risks you can pay attention with the Dangote IPOs are :
- Operational risk: This is the risk that a company's day-to-day operations don't work as planned, causing financial losses. For a refinery, this could include equipment breakdowns, accidents, unexpected shutdowns, or disruptions to production. A profitable company can still have operational risk.
- Currency risk: If you are a Ghanaian investing in a Nigerian company, you are dealing with two currencies. Even if the share price performs well in naira, changes in the naira/cedi exchange rate can affect what your investment is worth when converted back to cedis. So you are not only taking on investment risk. You are also exposed to currency movements. This applies to anyone in other countries
- Policy risk: It is the risk that government policies, laws, or regulations change in a way that affects a company's business or profits.For Dangote Refinery, this could include changes to fuel pricing rules, import policies, taxes, petroleum regulations, or government requirements
- Valuation Risk: This is the risk of paying too much for a company. A company can be successful and still be an expensive investment if the price investors pay for its shares is too high. So don't only ask: “Is this a good company?”
Also ask: “What price am I paying for a piece of this company?”
These are only a few of the risks associated with investing in an IPO.
The Dangote IPO has certainly generated a lot of interest, but before taking action, understand the investment, understand the risks involved, and understand your own ability and willingness to take those risks.
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