How is the price of the share decided in an IPO?

The company is required to produce a document, the prospectus, detailing specific information about the company and its plans. It is important to read this document prior to investing in the IPO.

The prospectus will state the price (or price range) at which the new shares will be offered. If the price is, say, 20 cents, this does not necessarily mean that the shares are cheaper than if the price is 50 cents.

To understand the value of the IPO, you should consider, among other things, how much money the company is looking to raise, the number of shares it is offering and the percentage of the company it is selling.

For example, if a company offers 25% of the company by selling 20 million new shares at 50 cents each, thereby raising $10 million, the valuation (also known as market capitalisation) of the company is $40 million.

In deciding the price for the shares in the IPO,  the company will also consider the likely earnings per share (P/E). A low P/E indicates that you are getting more earnings for the amount you have invested.  A company will endeavour to make their P/E competitive with other companies in the same sector.  

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