Well, this is not only true for India, but also for the rest of the world.
A total of 1,821 IPOs have taken place globally in 2021 so far. Out of this, 106 have come up in India.
By the end of 2021, the other 10Ps are expected to be listed on stock exchanges in India. The total amount raised through these IPOs is expected to reach 1 ton.
The Indian IPO market in 2021 is different not only because of the number of IPOs, but also because of the huge participation from retail investors.
A total of 14.2 million new investors participated in the stock exchanges in the financial year 2021. In the first quarter of FY 2022 alone, 7.1 million new retail investors became part of the financial market.
For a new investor, IPOs look extremely promising. The listing profit is huge and provides a great opportunity to make money in the short term.
But here’s something you need to know first investing in ipoWhether you are a first time investor or not.
IPOs can be very risky.
Considering the risks, here are some points that you can consider before investing in an IPO.
#1 Define your purpose
Before investing in an IPO, it is important to define your goals.
Are you applying for listing benefits, or are you looking for a potential candidate for your long-term portfolio?
Some IPOs may deliver excellent listing benefits, while some may initially list at a discount, but may be an excellent pick for a long-term portfolio.
Take the case of Zomato itself. It gave around 65 per cent returns on the day of listing. This will be a great opportunity for investors looking for short term gains.
However, Zomato’s shares have declined since its listing in July 2021. They are up only 12% now.
On the other hand, the shares of Anupam Rasayan India got listed in April 2021 at a discount of about 5% from its issue price. However, the company’s shares have jumped 70% in the past eight months.
You cannot predict whether the IPO will be listed at a premium or a discount. It depends on many factors.
But if you are a first time investor, It is always better to invest for the long term, This will help you get out of volatility in the short term.
#2 Understand the business
Warren Buffett said, ‘Never invest in a business you don’t understand’.
For a listed company, there are endless sources of information. But for a company that isn’t yet public, the draft red herring prospectus (DRHP) is a goldmine of information.
By reading the DRHP you can identify the strengths, potential opportunities and risks of businesses. You can also find out how the company is likely to perform in the medium term and long term.
If a company’s business model is beyond your understanding, it will be difficult to track its progress.
FMCG companies like Nestle have a simple business model which is easy to understand. They earn revenue by making and selling consumer products. You can easily track the growth of such companies.
However, new-age tech companies such as Zomato have complex business models.
Zomato leverages technology to deliver food at your doorstep. It also provides other services such as listing restaurants and their menus for people to eat.
The backend processing that takes place in terms of technology and manpower coordination can be confusing for some. Therefore, it is difficult to track the growth of such businesses.
Do not invest in any business that you find confusing.
#3 How will the company use the funds?
Each company has to disclose why it is going for the IPO and how it will use the funds.
You will find this information under the ‘Items issues’ section in the DRHP. Here the company will elaborate on how they plan to use the funds.
Why is this knowledge important to you?
There are two reasons…
First of all, it’s your money. Thus, you are entitled to know how it will be used.
Second, by knowing how the company will use the funds, you can gauge the sustainability and viability of the business.
Try to find out whether the company is using the money to increase its profits. If so, you can further evaluate whether it is a good investment or not.
#4 Why are existing shareholders selling their shares?
When a company goes for an IPO, it is often because the existing shareholders intend to sell their shares instead of raising funds through a new issue.
In such a case, all the proceeds go to the promoters and not the company. Hence, you have to be extremely careful before investing in such companies.
You can start by asking yourself why are existing shareholders selling their shares?
Surely they must be booking profits. But you can always figure out if they are exiting to take advantage of higher valuations.
Take Paytm for example. More than 50% of the funds raised by the company were through offers for sale by existing shareholders.
The market also thought the issue was overvalued. As a result, the shares of the company were listed at a discount from the issue price.
#4 Look at the financial position of the company
This is the most important segment for any business.
In DRHP, you will find information about the company’s profitability and financial position under the ‘Financial Information’ section.
Why do you need to view a company’s financial statements?
By studying the financial statements, you can see how much revenue a company is making, how much it is spending and how much profit it is making.
A profitable business has a higher chance of survival in the long run than a loss-making business. If a company has a strong financial profile, the shares will automatically perform well in the stock market.
Take Paytm for example, the company has consistently posted losses in the last five years. As a result, the company’s shares have underperformed despite being a popular brand.
The popularity of a brand does not determine its performance in the stock market. Do its basic principles.
Look for a company with strong fundamentals and a strong financial profile to invest in.
#5 Evaluation
You must have read analyst reports that say, ‘IPOs are undervalued’ 200 m’.
What is this 200 meters?
This is the value of the company. A company hires experts to value its business based on performance and other factors.
But what does this mean for investors?
Value investing has a concept called intrinsic value or true value. This measure determines the true value of a business. Based on the intrinsic value, you can determine whether the IPO is overvalued or undervalued.
An undervalued stock means, it is undervalued by the market. In other words, the company’s shares are trading below their actual value.
This means the stock has good growth potential or upside and minimal downside risk. Investing in a low-value business is preferable as it provides a margin of safety for the investors.
#6 Management background
It is very important to do background checks of the people running the company. Promoter and management are the main pillars of the company. They will take the company forward.
A company with a strong management team indicates better prospects for future growth.
Take the case of Hindustan Unilever.
The company is known to have a solid management team and a team that adheres to good corporate governance practices.
This can be seen in its ever-increasing share price.
On the other hand, companies like Satyam saw their share price fall due to a fraudulent management.
To finish…
Investing in IPO is a risky affair.
Of the 106 IPOs listed so far, 30 have been listed at a discount to the issue price. Many people have done well but you never know how the company’s stock will perform in the long run.
Take the case of ICICI Lombard itself. It is listed at 2% off. However, the company’s stock has more than doubled in the last four years.
If you had exited the stock on the day of listing, you would have incurred a loss as well as missed out on large long-term gains.
In a volatile IPO market, new investors make the wrong decisions in the heat of the moment. Don’t let this happen to you.
Participating in the stock market can be very exciting. But don’t let your emotions get in the way of your decision making.
While investing in IPOs it is always better to do your research and proceed with caution.
Happy investment!
Disclaimer: This article is for informational purposes only. This is not a stock recommendation and should not be treated as such.
(This article is syndicated from) Equitymaster.com,
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