You might have heard the term “a company goes public” this means that a private company has issued its shares in the form of new stocks to the public investors to raise money and this gives the retail investors an opportunity to invest in companies that could give good returns in the form of listing gains as well as capital appreciation over a period of time. Its important for retail investors like you to evaluate the Initial Public Offering diligently to make sure that you are putting your hard-earned money in good companies.
Listed below are a few important factors that should be considered before investing in an IPO:
Company Background:
Since it is your money which is at stake it is very important that you carry out deep objective research on the company background. Getting information would be a lot more difficult since it is a private company, there would not be a lot of analysts to review and find any drawbacks/Loopholes in the company but it is your duty to dig deep on-line or otherwise to find out the company’s finances, their competitors and the growth of the overall industry.
The company will publish all the relevant information during the time of an IPO but since it is the company that gives out the information it could be biased.
Going through RHP:
RHP (Red Herring Prospectus) is provided by the company going public which is verified by SEBI, this provides very crucial information regarding the company finances, its position in the industry, competitions, promoters, and the company operations. The prospectus does not include the stock price and the stock volume. Even though the prospectus is a bit of a dry read consisting of financial statements it is very important you go through it.
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Peer comparison:
It is one of the most widely used methods for the analysis of IPO shares. In this method what you do is compare the share price of the IPO with the share price of similar competitors which are already available in the stock exchange to identify whether the stock is overvalued or undervalued. You can compare very important ratios like price-earnings ratio (P/E), price-sales ratio (P/S), Enterprise value-EBITDA (EV/EBITDA), and many other relevant ratios with respect to the peer group in the industry which you believe is important to make the investment decision.
Peer comparison is the most useful tool because all the information required is already publicly available on the company website, prospectus, or in the company reports.
Keep an eye on the Lock-up periods:
There will be a lock up period during an IPO for private investors and the company employees ,it will usually be between 3-6 months during this period they are not allowed to sell their shares so as to prevent over saturating the market which would cause the share price to drop.It is a good idea to wait for the lock-up period to be over and see whether the private investors and the top management officials hold their stocks or not. if they hold their stocks it means that they have confidence in company and you can invest in it.
Also read: Here is how to apply for an IPO through ASBA
IPO money usage:
The prospectus provided by the company will include details of what the money from the IPO will be used for. The best IPO’s are the ones in which the money is used for growth-related activities such as implementing new technology, new market ventures, acquisitions, etc. these are the type of activities which will help in raising the company income and thereby increasing the stock price just make sure the company has a solid growth plan and structure.
You should be very cautious of investing in IPOs of companies that use the money to clear their debt and any other non-growth related activities.
IPO pricing:
You should be cautious and not just invest in a company because it is popular. In most cases such a company may be overvalued and oversubscribed (Demand is higher than the shares available) hence doing relative valuation and analyzing the price-earnings ratio (P/E), price-sales ratio (P/S) is a good way to find whether the stock is overpriced.
Qualitative and Quantitative factors:
Quantitative factors are the ones that can be expressed in numbers like the P/E ratio, EPS (earnings per share), etc., these can be calculated by using the information provided in the prospectus. Qualitative factors are the ones which are very difficult to put a number on, it is difficult to and these are generally used to assess the situation of not just the company but also the overall industry.
Management:
Good management is a very important qualitative factor that should be considered while choosing an IPO because every company depends on its leadership to carry out its vision.
Here are some points to keep in mind while investing
Be cautious: meaning if your broker is recommending you an IPO then do the background checks as listed above
Make Use of ASBA: ASBA (Application supported by blocked account) was introduced by SEBI and this application contains an authorization to block the amount in the your bank account necessary for the IPO stock allocation and the amount is only deducted if your application for the IPO stock goes through and your allocation is finalized.
Fill the application carefully: Ensure that you fill in all the details because incomplete applications are rejected.
Also read: Review on HPL Electric & Power Ltd IPO
Conclusion
Since there are many IPOs coming this year you might be very excited to dive into the IPO bandwagon but its important act prudently and not get carried by the euphoria.
Identifying and investing in a good IPO would reward you handsomely provided you follow the above mentioned processes diligently.
While investing in IPOs a sceptical investor who is well informed is likely to see his investments perform better than the one who is ill-informed.