With a strong pipeline of more companies expected to flood the equity market this year and early next year, it’s natural for many of us to feel FOMO (Fear of missing out). But before you jump into believing any biased opinions about a business or their public offer, let’s walk you through the entire gamut of IPOs and what to keep in mind before investing in it.
What is IPO?
Simply put, an IPO is both a process and avenue through which shares of a private corporation are offered to the public through new stock issuance. As IPO’s primary objective is to raise money by borrowing through the issue of shares to the public via the first public invitation in the stock market, it is thus termed as ‘Initial Public Offer’. Through an IPO, companies are able to raise equity capital by issuing shares to the general public, thus enabling the public investors to participate in the offering and giving the investor some ownership in the company in accordance with the value of shares allotted and owned. An IPO also marks the transition phase of a privately held company into a public company.
Now that you understand the basic meaning of IPO, you must be even more curious to know how to choose amongst various IPOs and get your skin into the game, right? Especially in the current market scenario wherein scores of IPOs are lined up, investors are certainly spoilt for choice. So, knowing which IPO to invest in can be a tricky task. That's exactly what we aim to assist you on by explaining some of the crucial evaluation criterion upon which you should identify the right IPO to invest your hard earned money in:
First be clear of your investment horizon, objective and risk profile
Before taking the leap of faith and jumping into the ocean of IPOs, you should be clear about three things
How long do you want to stay invested?
What do you aim to achieve?
And how much risk you're willing to take?
If you have the answers to these three questions you've made your life simpler. Being clear of your risk profile (risk averse, moderate or high risk taker) and the reason behind investing in IPOs would help make your hard earned money work for you. Also, be clear whether you wish to invest in the IPO just for a quick short term profit on listing day, or hold the shares for a long term. Remember that short term strategy would depend more on current market sentiment, whereas long term one would depend on the core fundamentals of the business.
Once you are clear about these three parameters, it becomes easier to eliminate those companies that do not meet your objectives and shorten the otherwise long list. Here are the next steps
Do deep researching about the company
Would you ever hand over your wallet full of cash and cards to a stranger? No, right? Then how can you invest your money into a company without enquiring and researching about it? When it comes to investing into a company’s IPO, never rely on hearsay or biased opinions even of your friends and family.
The best and probably the only solid way to zero in on any IPO is by first conducting deep research about the company. To help with this, you can download the company prospectus from its official website or even from SEBI’s website, and give it a thorough reading. The prospectus acts as a good starting point for your research. If you aren't able to understand parts of it or the financial jargon, a quick google search is all it takes to clear things up. The prospectus mainly contains information regarding the company’s financial performance, reason behind issuing an IPO, details about the promoters, dividend policy, regulatory and statutory disclosures, offer information, details about the management etc. We will also explain to you how to read the prospectus in the later part of this article.
Also to further complement your research, go through the media reports about the company and keep a tab on any recent developments regarding the same. To gauge how strong the company is fundamentally, check for red flags like cases of defaults in corporate governance, any legal disputes the company might have landed in, ongoing compliance issues, hasty managerial exits, etc . Only when you are fully satisfied on all fronts, should you proceed further with the IPO investment. Even though all this might seem time-consuming, never bypass this step. Your own research can help you discover some weak spots that can anchor your decision. As the saying goes - Devil lies in the details!
Know where your money goes
Once you have thoroughly researched the company whose IPO you want to invest in, the next step is to know where the IPO proceeds will go. Knowing what the money raised from IPO would be utilised towards, can give a glimpse regarding the potential of returns and growth. For instance, if the company intends to only repay the debt through the money raised from the IPO, then it might not sound like a lucrative option. But if the company says it plans to partly repay the debt and use the rest for purposes like expanding operations, discovering new markets, acquisitions or increasing production capacity, then it sounds like a good option, as it shows that the invested money will actually flow into the business and contribute towards potential growth.
Look at the valuation
Valuation is nothing but the worth of the company whose IPO you're interested in. There are not one but multiple techniques used by analysts and economists for arriving at a company’s valuation. Numerous aspects like the business' management, composition of its capital structure, prospects of future earnings, market value of its assets, number of stocks being sold in IPO, potential growth rate, financial performance, current market price of companies listed in the same sector etc are amongst the factors and metrics taken into consideration during valuation. One should ideally see how the valuation of a company fares vis-a-vis existing companies and competitors in the same industry when contemplating the idea of investing in its IPO.
Also, while there are techniques such as Return on equity (ROE), Price to earnings (P/E) ratio, price to book ratio etc that can be used to judge the valuation better. It's always a good idea to learn about these ratios. To add to your own research, look at what the financial analysts and economic experts are saying about that IPO, but take your own decision.
Check the supporting cast
Another crucial parameter to understand and judge an IPO is through its support cast, such as the promoters, underwriters, investment banks and major stockbrokers backing the IPO. This supporting cast plays a key role in sailing the IPO through. Look out for signs such as promoter’s stake pre and post the IPO (significant reduction can be a red flag), exit of anchor investors (exiting the company in totality can be red flag), track record of the investment bankers, etc. All these depict the potential quality of the company and its IPO. However, make sure to take these as positive signs, if present, but not solely rely on them or assume their presence as a signal of guaranteed returns. Above all, learn to always stick to your research and analysis of the company’s fundamentals as well as potential growth prospects before taking the final call.
Last but not the least, remember that scepticism is a positive attribute when it comes to investing in IPOs. Whenever you think of getting your skin into them, it’s always better to tread with caution. And besides the parameters discussed above till now, a ton of key information surrounding the company’s IPO is mentioned clearly in its DRHP. Given that the prospectus is amongst the most crucial pillars in the process of IPO, let’s understand the DRHP a bit more so that you can read and understand that in totality and accordingly take an informed decision.