With a large number of IPOs lined up in the coming months, Calendar 2021 is tipped to be a record year for investment in IPOs in India. The IPO Stocks listed in 2020 are currently trading above the issue price, with some having risen as much as 400% since listing. All of this makes IPO investing an interesting option for investors looking to enter the market. There are some big names like Paytm, Bajaj Energy, Nykaa and LIC expected to hit the market before the end of this financial year.
However, one needs to understand that just like the stock market, IPOs come with relative risks and due diligence is required before investing in them. Should you decide? invest During an IPO, here are a few points to keep in mind:
Always read the Hearing Prospectus: Draft Red Herring Prospectus, or DRHP, filed by a company Sebi when it intends to raise money from the public by selling shares of the company to investors. The DRHP also outlines how the company intends to use the funds raised and the possible risks to investors. Therefore, investors must go through the DRHP before investing in the IPO.
Use the proceeds: It is very important to check how the proceeds from the IPO will be used. If the company says it’s debt-only, it may not be an attractive option to consider, but if the company plans to raise capital to pay off some of its debt and expand its business or use it for general purpose of the company, then that shows that capital will actually flow into the business, which is great for an investor.
Understanding Business: Before investing, one should understand the nature of the business the company is in. Because, the size of the opportunity and a company’s ability to capture market share can make all the difference when it comes to growth and shareholder returns. On the other hand, an investor should stay away from an IPO, if the business practices are unclear as an investor.
Advertiser background and management team: An investor should closely check who is running the company. It is important to consider the company’s promoters and managers, who play a key role in all of the company’s activities and functions. The company’s leadership is responsible for driving it forward. The average number of years of the top management in the company also provides an idea of the company’s work culture.
The company’s potential in the market: With increased awareness about the company around the time of the IPO, investors can analyze the potential of the business in the market to understand its future prospects. If the company does well after raising capital, investors will get a high return on the investment made during the IPO. An initial public offering company must have a good business model to maintain in the future.
Company’s key strengths and strategies
: Investors can find a company’s key strengths from DRHP. One should also try and find out where the company stands in the industry in which it operates. By reading more about the company, its positioning and strategy, one can get an idea of the future business prospects.
Company’s financial position and valuation: The financial performance of the company should be examined in light of whether the company’s revenue and profits have been increasing or decreasing over the past few years. If sales and profits are growing, it will be a good investment. Investors should try to understand a company’s financial position before buying an IPO. One should also check the valuations, because the asking price can be undervalued, well overvalued or overvalued, depending on industry parameters and profitability.
Comparative valuation of the company: Investors should carefully research companies in the same industry. DHRP will compare with its peers – both in financial and valuation metrics. One can look at comparative valuations to check if a company’s valuation is in line with those of its peers.
Key risk factors: Investors can find risk factors from DRHP. Reading the risk factors is important to determine if there are any major concerns or risks associated with the company. Sometimes there are lawsuits and certain liabilities, including contingent liabilities, that can threaten a company’s future business prospects.
Investor’s investment horizon: An investor should have a clear investment opportunity. One has to clarify whether she intends to invest in the IPO for a quick profit on the listing day or if she wants to hold the stock for longer. Because the short-term strategy will depend on the current market sentiment, while the long-term strategy will depend on the fundamentals of the business.
Besides, an Investor should share his own research. If she believes in the company’s long-term growth potential, then she should consider investing in an IPO. Do not evaluate IPOs based on gray market premiums. An IPO can sometimes mean a great opportunity to buy shares at what one might call stealing. So, if one comes across a company that is undervalued, one should definitely take advantage of that opportunity. However, one should only invest in an IPO if it suits her financial goals and risk appetite.
The stock market is all about timing – when you enter the market and when you exit it. Sometimes the timing is right in an IPO, and sometimes, it’s better to wait. Make a decision based on how much risk you can accept and how good the business fundamentals are for the valuation. Be skeptical, When it comes to the IPO market, a skeptical and knowledgeable investor will likely fare better.
(DK Aggarwal is the CMD of SMC Investment and Advisors)