Information is the key to making wise decisions in the stock market, and information seems to be everywhere you look. However, as you dive into new securities offerings — including initial public offerings (IPOs) — you may find much of the data you come across isn’t relevant or up-to-date.
That’s where a stock prospectus comes in.
Prospectuses give you relevant details about the company, financials, and risks involved in a stock to allow you to make informed decisions when you invest.
What Is a Prospectus in Stocks?
A prospectus is a legal document that gives you detailed information about a company’s business, background, and finances before you invest.
The U.S. Securities and Exchange Commission (SEC) requires issuing companies to file a prospectus any time they attempt to sell securities to potential investors. This includes both initial public offerings (IPOs) and all future offerings, whether they’re public or private.
There are two different types of prospectuses:
- Preliminary Prospectus. A preliminary prospectus, also called a red herring prospectus, isn’t a requirement. Issues often file this document to gauge investor interest in their offerings. It includes information on the company’s business model, finances, management team, and risks, but doesn’t include any pricing or transaction information about an offering of shares or other securities.
- Final Prospectus. The final prospectus is the document the SEC requires. It includes all the information found in the preliminary prospectus, often with further details. The final prospectus also includes the offering’s transaction information, such as the number of shares the issuer is selling, the offering price, and the type of shares involved.
How to Read a Prospectus
Prospectuses are filled with detailed information about the companies that create them. Although it may seem cumbersome, reading them is actually a pretty simple task, much like reading a book. Simply comb through the prospectus and take note of key information it reveals.
What’s on a Preliminary Prospectus?
A preliminary prospectus is one that companies often use to gauge interest in their offerings. It comes with most of the information you’d find in a final prospectus, but not all. A preliminary prospectus typically includes:
- Business Name. One of the first things listed on a preliminary prospectus is the business name. In many cases, the name of the business is coupled with its stock ticker.
- Business Information. Most prospectuses start with a summary of the business. This includes the business model, its history, a short description of products, and the plan the company intends to follow to become a leader or maintain its leadership position.
- Potential Risk Factors. Companies usually include a summary of the potential risk factors toward the top of the document. The risk factors are usually explained further later on in the document. Pay close attention to these risks no matter how obscure they may seem.
- Management Team. A company is only as strong as its management. Companies display the strength of their management teams in their prospectuses as a selling point to attract new investors. The document also names any company principals (owners or members).
- Use of Proceeds. When you invest, you’re not interested in padding a management team’s pockets. You want to make sure the money you invest goes to good use in growing the company. The use of proceeds section tells you how the company intends to use the investments it collects.
- Type of Offering. The document tells you whether the offering is public or private.
What’s On a Final Prospectus?
The final prospectus is exactly what its name suggests — the final document outlining important information about the company and the transaction through which the company intends to offer securities.
The final document includes all the information found on its preliminary counterpart, often with minor changes and additional details. It also goes into detail about the financial information involved in the transaction at the center of the offering as well as the parties in charge of it. These details include:
- Number and Type of Shares. The final prospectus reveals the number of shares the company intends to sell and the type of shares they’ll be. For example, a company may offer 1 million common shares and 10,000 preferred shares.
- Offering Price. Shares can either be sold individually or grouped into units with exercisable options like warrants. Each unit is priced as a whole. For example, a company may sell one share and one warrant to buy one share at a future date at a total price of $5 per unit.
- Involved Parties. This includes the names of brokerages, investment banks, underwriters, and any other party involved in making the transaction happen.
- Fees. Financial professionals rarely work for free, and securities offerings are big business. The document outlines the fees the company expects to pay through the proceeds generated in the transaction.
In some cases, the final prospectus goes into further detail about the company’s capitalization structure, dividend policy, shareholders, and other material facts the company’s management team deems important for investors to understand.
The images below are snippets from Apple’s IPO prospectus from 1980. The full document is 47 pages long, and we chose example images we deemed most appropriate for teaching about what a prospectus tells you. You can read the company’s full prospectus on its website.
Below is the Table of Contents from the Apple prospectus. All information the company believes to be important in forming an educated investment decision can be found in the document.
The prospectus begins with a summary that hits the highlights of the document at a glance.
Apple’s prospectus summary starts with a brief description of the company, the products it sells, how it sells those products, and how it intends to grow. It goes on to explain that it intends to offer 4,600,000 shares to the public, after which 54,215,332 shares will have been in existence.
The prospectus explains the funds are needed to cover the cost of short-term debt and add working capital to the books.
Next, the document outlines selected financial data showing strong growth in revenue, net income, and earnings per share.
On page five of the document, Apple describes its dividend policy:
In a short paragraph, Apple explains that it doesn’t pay dividends and has no intentions to do so. Instead, the company plans to retain its earnings for use in growing the business.
In most cases, companies put a dedicated risk section into their prospectus. However, Apple proved to be the rare case that sprinkled its risk factors throughout the document. You can find the word “risk” in the document three times: twice on page 15 and once on page 18.
You should read a prospectus carefully for references to risk throughout, especially if the document doesn’t have a dedicated section that spells out the company’s risks.
What a Prospectus Tells You
A prospectus is designed to tell you everything you need to know about the issuing company. When you completely read through the prospectus, you should have a good understanding of what the company is and the product it develops. Prospectuses also tell you about the leadership behind companies and their experience, the companies’ financial performance to date, and how much the offering costs in fees.
One of the most important things a prospectus tells you is the risk you’re accepting when you make an investment. Every investment comes with risk, and it’s important to understand exactly what those risks are before laying your money on the table.
It’s also important to remember that although companies are required to outline risks in their prospectuses, there’s no required format for doing so. As you can see from Apple’s document above, some companies sprinkle their risk information throughout the document, rather than providing a dedicated risk section.
Keeping this in mind, you should always read the entire document before investing, especially if you’re investing in an IPO. Helpful bits of information often hide in the black-and-white content of relatively boring sections of legal documents. These documents are no different.
One of the most important parts of investing is asking questions. That doesn’t just apply to the companies you’re investing in — it also applies to the information you use in your research.
How Do You Get a Company’s Prospectus?
You can find most IPO and other offering documents from big companies with a Google search. For example, the Apple document above was from the early 1980s; I was able to find it in less than a minute by typing “Apple’s IPO Prospectus” into Google’s search bar.
You can also find these documents using the SEC’s EDGAR (an acronym for electronic data gathering analysis and retrieval) system. Use the keyword search function to type the stock’s ticker symbol and the word prospectus.
For example, if you’re interested in Apple documents, type “AAPL prospectus” into the search bar. The EDGAR system will retrieve every prospectus the company has filed as far back as its IPO.
What’s the Difference Between a Preliminary vs. Final Prospectus?
Preliminary prospectuses aren’t required by the SEC. These documents are used to gauge interest among prospective investors. The document includes most information found in its final counterpart with the exception of transaction information.
The final prospectus is required by the SEC. It includes all finalized information, including information associated with the offering transaction. It often includes more details or updates to the information found in a preliminary prospectus.
What’s the Difference Between a Stock vs. Mutual Fund Prospectus?
Stock and mutual fund prospectuses are both documents that tell you more about investments you’re considering. However, a stock prospectus gives information important to a single company’s investors, while mutual fund prospectuses give information important to potential investors in a mutual fund.
Mutual funds often release a required statutory prospectus and a summary prospectus, which is a condensed version of the statutory document. These documents include the following information:
- Fund Fees. The document details any fees you’re required to pay as an investor.
- Distribution Policy. You can also find in the document how the fund deals with dividends and its distribution policy.
- Investment Objectives. Each fund has its own unique investment objectives. The document tells you what the fund plans to achieve for its investors.
- Investment strategy. The prospectus clearly outlines the investment strategy the fund manager plans on using to meet the fund’s objectives.
- Asset Allocation. The prospectus tells you the types of assets the fund invests in.
- Fund Management. Learn about the management and team making investment decisions on your behalf when you invest in the fund.
What’s the Difference Between a Stock vs. ETF Prospectus?
As mentioned above, a stock prospectus provides information important to stock investors. Exchange-traded fund (ETF) prospectuses provide information ETF investors are interested in.
ETF prospectuses are closely related to mutual fund prospectuses and include everything listed in the summary of mutual fund documents above.
Prospectuses are important documents that tell you just about everything you need to know before taking part in an offering. Of course, it’s important to do further research and back up any claims made in the document before making a final investment decision, but it’s a great place to start your search for relevant information.
Although these documents are different for stocks than they are for mutual funds and ETFs, they’re important regardless of the type of asset you’re investing in. Even more so for IPOs, because they tend to provide the most up-to-date information on soon-to-be public companies.
Before you dive into your next investment, take the time to read its prospectus to get a better understanding of what you’re buying.