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Things To Look For Before Investing In An IPO

Evaluate the growth potential of the industry that the company operates in and estimate the company’s market share in the coming years.

India is no longer an exception to a global IPO frenzy. India Inc has thus far raised $9.7 billion, the highest amount in nine months over the last 20 years, through IPOs in 2021. In EY’s most recent Global IPO Trends report, IPO volumes increased 163% in the first half of 2021, and proceeds increased 245% year-on-year. With IPOs flooding the market, investors have a plethora of choices. However, it can be a daunting task to choose a good investment opportunity. To bring some method to your evaluation, you can consider the following steps.

Here are four steps that will help you identify an IPO worth investing in –

Understanding the business and reading the DRPH:

First, review the company’s historical performance, business model, and management credentials. The company’s unique offerings and attributes against its peers are important factors to evaluate to understand its competitive edge. Only once you are convinced with the financial health and management strengths that you should study further. The DRHP will have comparisons with the peers –- both on financial numbers and valuations.

All companies going through the process of IPO issue a red herring prospectus that contains information related to the company’s performance, media reports, website, annual report, and other sources of material that you can refer to.

Growth Potential and Role of management:

The best IPO to invest in would be companies that showcase solid growth potential. The substantial revenue alone does not guarantee growth potential. Partnerships, collaborations, investments in new-age technologies, start-ups, and innovation are many factors that you weigh when selecting a company. Evaluate the growth potential of the industry that the company operates in and estimate the company’s market share in the coming years. Do you foresee any growth in the market share?

Promoters and managers are the drivers of a company’s operations and functions. Looking at an average number of years spent by the top management in the company also provides an idea about its working culture, stability, and work environment.

Utilization of the Proceeds:

It is pivotal to check that the proceeds raised from the IPO will be used appropriately. If the company says that the proceeds will be utilised to clear debt, it may not be an attractive investment. However, if the company plans to pay off the debt and invest in expanding the business or use it for corporate purposes, then it is a good proposition to invest in.

Pricing of stock:

You can estimate the fair price of a stock through competition analysis. Two of the most commonly used multiples for this are Price-to-Sales and Price-to-Earnings. From the income statement, you can calculate these ratios by dividing the price of a company’s stock by its sales per share and net income per share respectively. It is advisable to refrain from IPOs of companies whose ratios are higher than competitors’; the stock may be overpriced. Sometimes shares are priced higher because the company is doing better than its competitors and has the edge over its competitors due to its unique offerings or performance.

When to invest in an IPO?

Below are a few steps to follow that will tell you when you should invest in an IPO.

Strong Track Record: Companies with solid performance and historical track record

Reason for going public: Understand the company’s intent for going public and its plan to utilise the money

Sector Performance: Don’t look at the stock in isolation. Take into consideration the sector’s growth prospects, performance, strengths, and opportunities.

Market Movements: Investors are optimistic when the market is high, but that does not guarantee that the stock you invest in will perform well. Be cautious of market movements. Everyone wants to be a part of the growth cycle, but trade carefully when the market performs well. Invest considering the strong fundamentals of the company.

When it comes to the IPO market, a well-researched, doubtful investor is likely to do better. So do your research before picking an IPO; look for the long-run growth potential of the company before investing. By following these simple steps choosing an IPO becomes easy and systematic.

Source: Business World

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