The IPO market is often crowded with overhyped listings and short-lived rallies. Beneath the glossy branding and investment bank endorsements lies a detailed filing—the S-1 prospectus—that reveals whether a new listing is backed by fundamentals or just financial engineering. Evaluating it thoroughly is essential for avoiding value traps and identifying high-conviction opportunities before they go public.

Who’s Selling, Who’s Staying

Before analyzing growth projections, examine the ownership structure and insider activity. If founders, executives, or early investors are selling significant portions of their stakes at the IPO, that is a material red flag. When capital is flowing out instead of in, the alignment between management and shareholders becomes questionable.

Lock-up periods, typically 180 days, prevent insiders from selling immediately. Still, once those expire, a flood of new shares hitting the market often puts pressure on the stock, particularly if insiders begin selling aggressively.

Historical context: Facebook's 2012 IPO is instructive. Early insider selling combined with a massive post-lock-up share release contributed to a nearly 50% drop in the stock’s value within six months of listing. Long-term investors who waited until the selling pressure subsided had a better entry point.

Can It Generate Sustainable Cash Flow?

Gross margins provide a quick window into a firm’s pricing power and competitive positioning. If margins are thin and costs are rising faster than revenue, the path to profitability becomes questionable. Also examine operating cash flow and capital expenditures. If growth is heavily subsidized by equity or debt issuance, it may not be sustainable in tightening capital conditions.

Case in point: Beyond Meat's 2019 IPO. While the stock surged more than 160% on day one, its weak cash flow, rising competition, and inability to achieve operating efficiency contributed to a 90% drawdown from peak.

Understand Dilution Risk and Balance Sheet Quality

Pay close attention to share issuance history. If the company has repeatedly raised capital through stock offerings before going public, expect further dilution post-IPO. This is especially common in unprofitable or pre-revenue tech and biotech firms, where capital needs are ongoing.

Review the use of IPO proceeds. If a substantial portion is earmarked to pay down debt rather than invest in operations or R&D, that’s often a sign the IPO is providing liquidity for insiders or private equity sponsors, not fueling growth.

The Hertz 2006 IPO is a cautionary example. Loaded with $17 billion in debt, much of it imposed by private equity owners before the listing, Hertz struggled under financial pressure for over a decade before ultimately filing for bankruptcy in 2020.