How Do You Read a Stock Prospectus?

When a company goes public, through a process known as an initial public offering, or IPO, it also files a prospectus.

It’s pretty different from the prospectus an ETF or mutual fund files, because it’s likely to contain many more details. The average investor might find much of this information confusing.

That said, it’s still important to be able to read a stock’s prospectus, especially if you’re considering investing in a company. The prospectus can give you an important snapshot of what’s going on inside the company.

What is a prospectus?

In the case of a U.S. stock, the prospectus is called an S-1 filing. (If a non-U.S. company files for an IPO on a U.S. exchange, it files something called an F-1).

Companies are legally required to file this document, and just like a fund prospectus, you can find the S-1 of any public company at the SEC website, called EDGAR.

What will you find in the S-1? ou You’ll get a sense of the company’s performance and other details that relate to how it operates.

For example, you’ll find out how much money the company actually makes, how much debt it has, and whether the company is profitable. You’ll also find out who runs the company, and how well they’re compensated.

Here are some of the most important things to look for in a stock prospectus:

The prospectus can give you an important snapshot of what’s going on inside the company.

Investment bank: The investment bank, or the underwriter, helps the company go public by purchasing the shares and reselling them to investors. It also makes a market for the stock. That means it ensures there are enough buyers and sellers of stock on the first day the stock trades. By knowing which investment bank the company used to go public, you can get a sense of the reputation of the financial backers behind the company.

Number of shares to be sold to the public: Near the top of the S-1, the document will also tell you how many shares the company is selling, and how much money it hopes to raise through the sale. For example, the prospectus may say that the company plans to sell 1 million shares at a price between $14 and $16 per share. That means it’s hoping to make between $14 and $16 million by selling shares. (A lot goes into whether or not the company can actually sell the shares for that much money, and at the end of the day, it may not be able to do so if there is too little demand for the shares.)

Balance sheet: This portion of the prospectus lays out the company’s assets, as well as any liabilities, or debts, it may have. It will tell you how much cash a company has on hand, as well as the value of its assets, which could include property, machinery, or office space. It will also tell you the dollar value of its debts, which is a critical number to know if you’re considering investing in any company. The balance sheet can help you determine the actual value of a company.

Income statement: This will tell you lots of things about a company’s operations. Two of the most important things are revenues, sometimes referred to as sales. The other is net income, or profit. The income statement will tell you about the cash flow from operations of a company, usually over a period of two to three years.

Management: The company’s executives are also named in the S-1, as well as the members of the board of directors. They’re important to know about  because they lead the company, and will have a big impact on the performance of the business. In the section about executives, you’ll also find information about their salary and other compensation, not to mention how much of the company they own.

Risks: Companies that are just listing on an exchange are likely to have more risks than mature companies, and those risks are detailed in the S-1. These can include market risks, due to competitors in the same space, the general ability to get loans to fund operations, regulations that can tamp down on earnings, or risks from having an executive who defines the company, and without whom the company could experience difficulties. The risk section might also tell you if the company has any ongoing litigation that could impact earnings and performance.

Good to know: The prospectus, or S-1, is just the start. Public companies are required to file quarterly financial documents with the SEC, called earnings reports. They must also file annual documents detailing executive compensation, and any important changes or developments that affect the company and its potential performance.