A hot issue IPO refers to an initial public offering (IPO) of shares of a private firm that has generated large-scale public interest. A hot issue is usually accompanied by high volatility, investor excitement, and price run-ups on the first few days of trading.
Hot issues are often talked about in the media for weeks, if not months, in advance of the actual IPO. The resulting excitement attracts all types of investors, ranging from long-term investors, who believe in the potential of the firm, to short-term speculators who want to flip the shares for quick profits.
This can easily lead to wide swings in value that can result in big gains for some and substantial losses for unsuspecting investors.
What Is a Hot Issue?
A hot issue is any IPO that generates high demand in the investing public. Hot issues tend to occur more frequently among hot new tech companies, during economic expansions, when investors are on the prowl for the next “disruptor.”
Investor excitement for hot issue IPOs can be generated during the investor roadshow, or enhanced by media coverage in the months leading up to the IPO date.
Hot issues are characterized by extreme price volatility during the first days of trading. New investors should be cautious when considering hot issues, as large price run-ups may or may not be reflective of the firm’s actual fundamentals.
How a Hot Issue Works
A hot issue starts off like an ordinary IPO, or initial public offering. The company that wishes to initiate an IPO process contracts with an underwriter, or team of underwriters (underwriting syndicate), to take stock of its existing business and market its shares to the public.
The company starts by filing a form S-1, which registers the firm’s new shares with the Securities and Exchange Commission (SEC) and is required for all new domestic issuers who wish to offer shares for sale to the public.
The issuing company and its underwriters will then embark on an investor roadshow which usually takes place over several months. During this process, they will meet with and present to various institutional investors across the country.
Roadshows are intended to market the shares and generate additional enthusiasm for buying the IPO stock. These occur well in advance of the actual pricing date and are another opportunity to introduce the firm and its management to the public.
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Pricing Hot Issue Shares
Once the new issue is ready to price, the underwriters will size the issue and price the shares at a level that they think will generate high demand for the shares.
Generally there will be a limited number of shares available to trade for new issues, as the actual number of shares issued will be sized around the new firm’s corporate financing needs — raising capital being the primary reason companies go public.
Limiting the supply of shares can drum up excitement for the stock, however most issuers typically have shares in reserve in case the IPO ends up being significantly oversubscribed.
The IPO underwriters then take pre-orders for the stock and resize/reprice the issue based on the investor interest. Once the shares are sold, they are transferred to institutional investor accounts, based on the allocations made through their order book.
The institutional investors typically turn around and flip the IPO shares on the market for large profits, but in some instances may hold onto the new shares, depending on their needs.
High Trading Volume Impact
High trading volume on hot issues result in high volatility and often an initial spike in prices during the first few trading days, particularly if the shares were multiple times oversubscribed.
If the share price spikes quickly on the first day and falls off in the following days or weeks, this could signal an artificially low IPO price or high speculator demand.
Due to the initial feeding frenzy around hot issue IPOs, they’re popular targets for speculators who wish to flip shares for a quick profit, often within the same day.
If long-term investors are interested in a particular hot issue, it may be prudent for them to step back and wait for the volatility to subside before initiating their own position, particularly in times of high market volatility.
The Takeaway
While it’s easy to get sucked into the excitement surrounding a hot issue IPO, investors should be careful in the first few days of trading, as initial volatility may lead to large losses.
It sometimes pays to wait a few days, or even weeks, for the initial trading volume to subside and for share prices to settle at stable levels.
Retail investors may encounter difficulty accessing hot issue IPOs at IPO prices out of the gate, as initial allocations are typically only offered to large institutional investors.
If you’re trying to participate in an upcoming IPO, SoFi’s Active Invest app can offer access to new hot issues, at IPO pricing, for eligible members. SoFi’s IPO investing feature offers the unique opportunity to participate before shares start trading on the market.
FAQ
What is a hot issue stock?
A hot issue stock is a new initial public offering that has garnered widespread attention among the investing public.
Hot issue stocks are typically characterized by being oversubscribed and typically trade at a significant premium above the offering price once shares hit the aftermarket.
What is an issue in an IPO?
An issue in an IPO is when a private firm goes public for the first time via the initial public offering process. This involves offering its shares for sale to the investing public.
What are hot shares?
Hot shares can be any stock that is highly in demand with investors. These usually involve new issue stocks that have run-up in price, but can involve any stock that has seen heavy bullish price action.
Photo credit: iStock/Yasuko Inoue
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