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IPO Investing: Here are some effective guidelines!

Sep-18-2019Blog by – Mr. Dhruv AjmeraRead Time: 4 Min.Word Count: 883190IPO Investing: Here are some effective guidelines!
An initial public offering refers to the process of offering shares of a private corporation to the public in a new stock issuance.  Companies must meet all the statutory and legal requirements to hold an initial public offering. Well informed investors are always on the lookout to invest in IPO. While IPOs facilitate the transition from a private to a public company, it also allows public investors to participate in the offering and offers an opportunity to make both short term and long term gains.For IPO investment in India,one of the most important tools to get all useful information about the company is the Draft Red Herring Prospectus (DRHP).A Draft Red Herring Prospectusis when a company that is planning to raise money from the public provides detailed information about its business operations and financials.The IPO price is based on the valuation of the company using fundamental methods of valuation. The most common technique used is discounted cash flow, which is the net present value of the company’s expected future cash flows.

Here are a few useful factors to be considered before investing in IPOs.

Role of underwriter: A company planning an IPO selects an underwriter or underwriters. They will also choose an exchange in which the shares will be issued and subsequently traded publicly.Companies hire investment banks to market, gauge the demand, set the IPO price and date etc.An IPO can be seen as an exit strategy for the company’s founders and angel investors.

IPOs are in lots:Before you decide to invest in IPO, remember that when the IPO if floated in the market, the prospects for future growth are likely to be high, and there would likely be a rush to participate in this process. Given that that the IPO is a primary market for shares, allotment of IPObasically offers shares in lots like 10, 20 etc. You can only bid for multiples of these lots.

Draft Red Herring Prospectus: Securities and Exchange Board of India, or Sebi, has made it mandatory for companies to file a DRHP before going to the Registrar of Companies (RoCs). Sebi reviews the offer document and checks if adequate disclosures are made. It includes details about company’s promoters, reason for raising money, past performance, industry trends etc.

Past performance of company: Just because the company is not yet listed on any exchange does not mean that you will not be able to check its past financial and operational performance. In fact, it makes a lot of sense to put up serious efforts in understanding the business model of the company and consistency in its financial records.

Promoter background information: Remember that the background and competency of promoter(s)matters a lot when it comes to investing in IPOs. Ifthe IPO is from a reputed business house with a history of solid performance in the market, then there is a possibility that the newly listed company would do well in future and as such would generate a lot of investor interest as well. This would directly impact your returns from the IPO.

Industry growth drivers: Getting a thorough idea about the industry the company coming up with the IPO belongs to is critical. Normally, the IPO investments in India that have created wealth are the ones that have a much focused business model with plenty of room to be scalable. A growing consumer base and healthy financials also ensure that the IPO turns out to be a dynamic wealth creator for you.

Capital Structure Of the company: Given the fact that the IPO is primarily aimed at raising long term finance for the company, the post issue capital structure of the company and the debt levels matter a lot. Avoid companies with a high debt/equity ratio. Also find out how the company plans to use the funds after the listing. If the funds from the IPO are going to expand operations or build new capacities, it would ideally create lot of value for the investors in coming years.

Checks on compliances: Before investing in an IPO, it is prudent to check if the company has run into any legal issues or environmental litigations. Also, unexplained contingent liabilities, red flags by the regulator, uncertainty about the long term success of the products could also warrant that such stocks are best avoided. It is apparent the company is just too lax on the legal and compliance front and that does not give you too much comfort.

Conclusion: Remember that unlike shares, you will not be directly able to invest in an IPO as a lot depends on the demand for an IPO. If there is a heavy buzz around the stock, the market gets crowded, resulting into oversubscription. This means that while some investors would get allotted a lower number of shares than they asked for and some may not even get any shares as well. Plenty of times, such heightened optimism results in a hefty surge in the stock price immediately after the listing- called as listing gains. One can pocket this frenzy by selling shares though it is advisable to hold the stocks for a longer period of time if the business model is strong as the company can turn into a multi bagger over a period of time. 

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