Investing in an IPO can earn far greater returns than even the most generous savings accounts and bonds, but they are high risk investments so think carefully before you invest.

What is an IPO?

An IPO is an Initial Public Offering (sometimes known as 'floatation') which is the first sale of stock or shares by a private company to the public. Quite often IPOs are offered by small, young companies looking for capital to expand, but larger private companies can also float to become publicly traded.

When a company issues an IPO and sells shares it ceases to be a private company and becomes a public company. By selling shares in the company, it exchanges ownership with you in return for money.

If the company is successful and its value increases, so will the share price and the value of your investment. If you sell your shares at this point you will have made a profit. Of course, the share price can go down as well as up, in which case you investment will decrease.

With such a large element of risk involved, how do you know which companies will represent a good investment, and which ones to avoid?

Why should you invest in an IPO?

By buying shares at an IPO can be a quick way to make great returns on your investment. By being an investor from the outset you'll have the opportunity to potentially get shares at their lowest price and make a killing, especially when the market is doing well.

There are plenty of IPO success stories of investors doubling and tripling their investments within a matter of weeks.

However, this is rarely the reality and investing in an IPO at the offering price doesn't mean that you are buying at the lowest price; there are always risks involved and stocks can just as easily go down as well as up.

Understand the risks

Investing in an IPO is a risky business and there is no guarantee of a return on your money, so you need to be aware that your shares could be worth less than you originally put in. In a worst case scenario you could lose it all; is this a risk you're willing to take? For this reason you should only invest money that you can afford to lose.

IPOs are notoriously risky as it's nearly impossible to predict what the stock will do. There's little historical data to analyse, and quite often IPOs are of companies looking to grow or change, which lends more uncertainty to their future performance.

What do you want from your investment?

You should also consider what you want your investment to achieve. Are you looking for the growth of your shares over time? Shares tend to be a longer term investment, and you may have to tie you money up for a few years, can you afford to do this?

If you're risk adverse, think carefully about whether an IPO is for you. If you're unsure whether you should invest, our guide, 7 Questions You Must Ask Before You Invest, will help you decide.

If you're still unsure take a look at our Savings Account comparisons for a safer alternative for your money.

Find a new IPO

If you're happy with the level of risk then you're next step is to find a suitable IPO for you to invest in. Try to keep abreast of what is going on by reading financial publication like the Financial Times, or visit the London Stock Exchange website or an IPO calendar site, which lists upcoming IPOs.

Get a copy of the prospectus

Once you've found an IPO that looks the business get a copy of the prospectus. This document should contain all the information you'd need to make an informed investment decision. You should be able to download this from the company's website, or you can contact them directly to get a paper copy.

What should you research?

If you're investing in a big company you may know a bit about them already, but if it's a new company you'll have more work to do.

Study its business plan, risks, management and its rivals. There's no historical market performance so profitability, borrowing and cash flow are all important areas to look at. What sector is in? How does it compare to its rivals? How have they performed?

Think about a fair price you're willing to pay, if you pay over the odds your chance of making a profit are greatly diminished. Don't skimp on the research; this is the most important park of buying shares in an IPO, and if done right you could find a great investment.

Get your research wrong or don't do enough, and you could sink your money into a company doomed to failure!

How to buy IPO

So you've assessed the risk and done your research, it's time to buy your shares!

Be aware that buying stock in an IPO isn't always easy, and you can miss out if it's a popular listing. Firstly, you'll need a share dealing account through which you can buy your shares.

When you apply for shares think carefully about how many you want to buy. If the IPO is oversubscribed, i.e. more demand than supply, you may not get all the shares you want. There will be a small window in which you can invest - so act quickly!