Investing in initial public offerings (IPOs)? Checklist for You

In recent years, India’s IPO market has become highly active. In a world where more and more firms are launching initial public offerings, it’s more important than ever to understand the fundamentals and other aspects of the offering before hopping aboard!

The investment banks that oversee and sell the company’s initial public offering (IPO) are known as underwriters. An initial public offering or IPO investment by traders helps in the establishment of a trading market for a company’s shares.

In general, initial public offerings (IPOs) are a lot of fun! In booming IPO times, many ‘IPO enthusiasts’ and brokers alike tout, “Put your money in that ‘hot’ new offer for fifteen days in any popular Indian company IPO and experience an unequalled ROI upon listing!” While the substantial profits provided by ratnas like Coal Indias’ and Reliances’ of the market cannot be overlooked, one must also consider the other side of the story. 

Consider this: investors saw the red in almost three out of every five offers from April 2020 to March 2021 among companies listed! To put it another way, at least 60% of the IPOs and FPOs that were listed this year left investors with burned fingers – and in some cases, horribly burned fingers! This article is not meant to discourage you from investing in IPOs and FPOs. There are a lot of great firms out there that have a lot of potential to expand and create money for their shareholders. But, before you go out looking for that ‘hot’ new deal, keep the following in mind:

Explore more: How is an Initial Public Offering (IPO) valued?

Get the fundamentals right. Pay attention to the basics.

In a rush to make a quick buck from the market, it’s common to overlook the company’s fundamentals. Many IPO junkies are so preoccupied with riding the Grey Market Premiums that they don’t even bother to learn about the company or what it does, let alone the balance sheet position or profitability! Investors should examine the IPO Grading Document from credit rating organizations to learn about the company’s fundamentals. In India, credit rating agencies assign IPO Grades on a scale of 1 to 5, with 1 indicating relatively low fundamentals and 5 indicating that the company has good fundamentals compared to other listed entities.

Stay away from the ‘boom’ effect.

Well, just because your known friend, broker, manager, or journalist claims the company will be the next Infy doesn’t mean it will be. Keep in mind that it is the goal of investment bankers and issue managers to achieve maximum subscription, so they may inflate the hype. Avoid the herd tendency by reading the Red Herring Prospectus, which is the single most significant document containing a wealth of information and disclosures about the firm and its operations. Examine the promoters’ standing by looking at their background, industry experience, and the performance of other companies they have supported. Check to check whether the promoters or the firm are involved in any major lawsuits or have any other risk issues. A brief glance at these items will ensure that you do not invest only based on hunches, rumours, or “hot” advice.

Assess the company’s performance.

At the end of the day, share prices reflect how well a company is performing and how well it is likely to perform in the future. Obtaining a copy of the company’s financial records for the preceding several years and methodically going over them will undoubtedly be worth your effort. Examine the company’s balance sheet and profitability figures, and compare them to similar companies in the industry. Keep in mind that if a company does well, the stock will follow suit. Keep an eye out for financial statement window dressing. Examine whether the data are comparable, superior, or inferior to those of similar companies in the industry. It’s astonishing how some loss-making businesses turn profitable just a quarter or two before their initial public offering! Check to see if there is a significant increase in the numbers soon before the issue for no apparent cause.

Earnings (P/E) Ratio

Examine the Price to Earnings (P/E) Ratio in relation to the price band and compare it to the company’s peers. The P/E Ratio is a measurement of how many multiples the market price would be beyond its existing profit levels. The usual rule of thumb for P/E is that the lower the P/E, the better for the investor, because a lower P/E multiple effectively implies that you are getting to acquire something for a lesser price when the company’s earnings are taken into account. However, keep in mind that during booming times, it’s easy to get carried away on this front because peer P/E prices are also at high levels.

Examine the items and their future prospects.

Examine whether the issue’s objectives appear to be in line with the company’s present and future prospects. Check to see whether other companies in the group are doing the same thing and if the company intends to use the proceeds in a way that is in its best interests or that will help other companies in the group. Take a peek at what the promoters will be holding after the issue. Reduced promoter confidence in the company’s future prospects could be indicated by a decreased post-issue stake.

It’s cheap, but it’s also quite pricey!

Read more: How to Choose most Promising Initial Public Offerings( IPO) to Invest?

“It’s far better to buy a fabulous company at a fair price than a fair company at a wonderful price!” stated legendary investor Warren Buffett. Now, whether or not the quote appeals to you depends on how you see certain of the low-cost stocks. Many investors are attracted to IPOs because of the small tick size, believing that it will allow them to purchase a larger number of shares. They have a tendency to buy low-cost, low-value stocks, only to regret their mistake later. At the same time, keep an eye out for really high-priced IPOs. Keep in mind that, no matter how promising a company’s future prospects are, a high IPO price will eat into the likelihood of eventual appreciation. Comparing the company’s EPS to the average P/E Ratio for peer companies might help determine what is a reasonable IPO price. You might be better off buying from the secondary market if the price range appears to be much extended from the reasonable price.

Overall, the time and effort you put in before jumping in to take some of these basic safeguards is likely to keep your money a lot safer! Do not invest if you believe the price is too high or you are unsure about the company’s prospects, and do not invest simply because your friend, broker, butler, or barber has done so! If you’re still considering taking the plunge into investing, get things rolling by opening a Demat account with Nuuu.