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IPOs are exciting to stock market investors in the same way that a big-ticket film release is exciting to the general population.
Introduction: The popularity of IPO investment stems from the popular logic that when one buys the stock of a company during its Initial Public Offering, one is getting the stock at the lowest possible price. The general understanding – or the general expectation, to be more precise – is that the price of the stock will only increase from here onward. For the most part, this is indeed the case. However, it need not always be the case. Investors need to play their cards right.
So what does “playing one’s cards right” look like in the context of an IPO? Well, the process spans careful selection, impeccable paperwork and punctuality – here are 7 considerations that any investor needs to pay heed to before investing in an IPO:
1. The company’s historic performance
You might not have historical stock pricing to go by unless the IPO is an Offer for Sale, where the initial stakeholders sell off their stake in the company on the stock market. They often do so once they have made their targets. Alternatively, companies might hold an OFS in order to comply with minimum public shareholding norms for large companies as stipulated by the government. If the company is already publicly listed and simply carrying out an OFS, you will have historical stock pricing to help you evaluate the stock’s potential. What has its growth trajectory been over the last few years? Does the growth rate match your earnings targets and your investment horizon?
Alternatively, if the company is raising capital and only now becoming public – via the IPO – you have no historical stock pricing to go by. But you can go through balance sheets, P&L statements, cash flow records, annual and quarterly reports, and any other financial data that you can get your hands upon. Go through the news about the company and be sure that you know about all the big headlines it has made in the last couple of years.
2. The sector that the company operates in
Once you know the company inside-out (and we’re not exaggerating) it is time to widen the scope of your research and delve into the sector’s health and opportunities.
Comp set: You want to now observe the company’s performance against its peers and competitors. You might be excited about Company A’s 20% profit during 2020 and willing to park your capital with them by investing in their IPO. But is that 20% profit actually commendable if its competitors, Company B and Company C, clocked profits of 27% and 29% respectively?
Taxation and policy: Imagine this hypothetical situation. Jatin is about to invest in the top-selling tobacco company in a given geography. However, what Jatin has not noticed is that there have been articles in the news every two to three months in the last year, about the government potentially adding a new tax for the sector. Jatin needs to factor in the fact that the profitability of the tobacco companies will be affected by the new tax.
3. The company’s future plans and outlook
When a company intends to go public, it has to file a draft herring prospectus with the Securities and Exchange Bureau of India (SEBI). You must get your hands on this document and check the following in addition to what we have listed above:
- Use of IPO proceeds
The Draft Herring Prospectus has to mention what the company intends to spend the investor capital on. Is the company unable to manage its debt and therefore going public? Or are the funds being used for expansion? You ideally want to invest in companies that are about to grow on account of expansion rather than a company looking for a lifeboat.
- Legal situation
Companies with a lot of legal stalemates in their closets could mean trouble for investors down the line. You never know when their business might get stalled or when they might have to pay hefty penalties.
- Management
A company’s future is determined by the people at the wheel, running things on a daily basis. You want to ensure that the members of the management team have a clean track record.
4. Make some quick calculations and comparisons
Now you have all the information required to check the following :
- How do the company’s earnings compare with the share price they are asking for?
- How does the historical stock price (in case of an OFS) growth compare with your earnings targets?
- What is the price difference between the initial share price being quoted by this company and the stock price that any of its competitors might have gone public at? Inflation accounted for, how do they compare?
- What do your potential earnings here look like as compared to another stock within the same sector or any other impending IPOs?
5. Quick portfolio re-look, general comparison and market pulse-check
Now it is time to check whether the proposed IPO investment sits well within your portfolio. Ideally, you’re looking to not have too many companies within the same sector.
You’re also looking to invest across asset classes. Evaluate whether you would rather park the capital you are intending for this IPO, in another asset class that you’ve been meaning to invest in. Portfolio diversification is essential for risk minimization.
You should also check the overall market situation when you are about to invest. A market that is at an all-time high is usually progressing towards a correction, although one might not be able to tell how far down the road the price drop is.
6. Check the IPO dates
If you’ve gone through all of the prior steps and have ascertained that this IPO is indeed for you, be sure to check the IPO allotment dates in order to submit your application in time. Steer clear of last-minute subscription to avoid disappointment.
7. Apply correctly smartly
Fill your IPO application correctly and thoroughly. When applying online – like when you use the Angel Broking app - you may go ahead and apply via UPI which certainly beats the whole DD process and hassle of applying physically.
Opt for minimum bid amounts, apply using different application numbers (so multiple applications but from multiple Demat accounts of friends and family) and select a higher price band or a higher cut-off price – but ensure it is in line with your investment goals.
Closing thoughts: An IPO can be an amazing investment proposition if the company is headed for high earnings in the future and if the socio-political environment is conducive. However, before investing in an IPO must always get his hands dirty digging up all the company’s secrets before investing.
Anyone can invest, irrespective of age, occupation or gender. However, you must always evaluate the risk and reward relationship in any investment and understand how these tie in with your investment goals and your risk appetite. Most of all, you should always take time out to understand how a given investment or asset class works – good job on getting a head start by reading this blog. Keep it up. When you’re ready, you can download the Angel Broking app free of cost and start your investment journey with Angel Broking.
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