What is a stock prospectus and how do you read it?

You’ve probably heard online chatter about the latest stock people are predicting to make it big. But just because there’s a new investment on the block attracting attention, doesn’t mean you should make it part of your portfolio.

Anytime you consider investing in a security, it’s crucial to gain some knowledge about it. That’s especially important if a company is new to the market and making their initial public offering, or IPO.

Feel free to gather some info from Twitter or TikTok, but to really get in the know, try reading a stock prospectus.

In investing, you have many ways to research stocks, including using a stock prospectus. A prospectus is a document required by the U.S. Securities and Exchange Commission (SEC) that describes what the stock is and outlines the level of risk associated with making an investment in it.

The prospectus must outline all opportunities, risks and financial details about the company that’s selling stock to the public. It includes information about the company’s history, management team, financial performance and intended use of funds. 

When a company goes public, it must first file a preliminary prospectus as part of its IPO registration process. The preliminary document, sometimes called a “red herring,” is mostly used as a way to gauge interest in the proposed security, but it doesn’t contain details such as the number or price of shares. However, after a company has issued an IPO, this detailed information will be included in the updated and final prospectus, otherwise known as a “statutory prospectus” or “offering circular.” 

A company’s prospectus is available to anyone, including investors, regulators and any other interested parties.

The easiest way to locate one? Visit the SEC’s Electronic Data Gathering, Analysis and Retrieval (EDGAR) database.  Search for a specific prospectus using the company/mutual fund name, ticker symbol, filing date or their central index key (CIK). In addition to the prospectus, you can access a company’s annual reports, including financial statements, through EDGAR.

You may also request a company’s prospectus through your broker or by contacting the company’s investor relations department. Some companies provide a direct link to their prospectus or a prospectus request form on their website.

The prospectus is designed to assess if a new investment is right for the goals, risk tolerance and current investment portfolio of a potential investor. 

At the top of a prospectus, important details are laid out in the summary section. You can learn how many shares of the stock the company plans to sell and at what price. The summary also reveals why the company is looking to sell stock, as well as the management team’s broad business objectives. Once you understand the company’s business model and goals, you’ll want to carefully consider the risk factors the prospectus lays out. Do they align with your risk tolerance? Or is the company riskier than what you’re willing to take on? 

You should also consider whether there’s any overlap between the security or the prospective fund and your current investments. Ask yourself: Does the investment compliment your existing portfolio holdings or simply replicate something you already own? 

Mutual funds are also required by the SEC to file a prospectus. Like a stock prospectus, a mutual fund prospectus lays out some basic, yet crucial, information for investors. One key difference between a stock prospectus and a mutual fund prospectus is that the latter will likely include information about the fund’s investment goals and strategies to pursue them.

A mutual fund prospectus also discloses the fund’s fees and expenses and its past performance. The fund’s performance and risk are disclosed as a comparison to a benchmark, like the S&P 500.

An online meme or video may pique your curiosity about a particular investment. But before putting any money in the market, it’s a good idea to review a prospectus to make sure the stock or mutual fund you’re considering is a good fit for your individual investing goals.