With a large number of IPOs slated for the coming months, the 2021 timeline would be a banner year for investing in IPOs in India. IPOs that were listed in 2020 are now trading above their issue prices, with some having gained up to 400% since listing. All of this makes IPO investing an attractive option for investors looking to enter the market. A few big names like Paytm, Bajaj Energy, Nykaa and LIC are expected to hit the market before the end of this fiscal year.
However, it should be understood that just like the stock market, IPOs carry a fair share of risk and that due diligence is required before investing in them. If you decide to invest in an IPO, here are a few things to keep in mind:
Always read the red audience leaflet: The Draft Red Herring Prospectus, or DRHP, is filed by a company with Sebi when it intends to raise funds from the public by selling shares of the company to investors. DRHP also explains how the company intends to use the money that will be raised and the possible risks for investors. Thus, investors must go through the DRHP before investing in an IPO.
Product use: It is very important to check how the proceeds of the IPO will be used. If the business says that only the debt will be repaid, then this may not be an attractive choice to consider, but if the business is considering raising funds to partially repay the debt and expand the business or l ‘Use for general business purposes, this shows that the fund will actually flow into the business, which is good for an investor.
Understanding the business: Before investing, one must understand the nature of the business in which the business is located. Once she understands the business, the next step is to recognize the new opportunity in the market. Because the scale of the opportunity and the company’s ability to gain market share can make all the difference in terms of growth and shareholder returns. On the other hand, an investor should stay away from an IPO, if business activities are unclear as an investor.
Background of the promoter and management team: An investor should take a close look at who is running the business. It is important to take a look at the promoters and managers of the company, who play a key role in all of its operations and functions. The management of the company is responsible for moving it forward. The average number of years top management has spent in the company also gives an idea of its work culture.
Potential of the company on the market: With increased knowledge of the company at the time of an IPO, the investor can analyze the potential of the company in its market to understand future prospects. If the company performs well after raising capital, investors will experience a high return on investment during the IPO. The company doing an initial public offering should have a good business model to maintain going forward.
Company strengths and strategy
: Investors can determine the key strength of the business from the DRHP. It is also necessary to try to know the position of the company in the industry in which it operates. By reading more about the company, its positioning and its strategies, one can get an idea of its future prospects for the company.
Financial health and valuations of the company: The financial performance of the company should be verified in the context of the growth or decline of its revenues and profits in recent years. If income and profits increase, it would be a good investment. Investors should try to understand the financial health of the company before purchasing an IPO. Valuations should also be checked, as the offer price may be undervalued, fair valued, or overvalued, depending on industry parameters and profitability ratios.
Benchmarking of the company: Investors should closely study the company’s peers. The DHRP will have comparisons with its peers – both on financial numbers and valuations. One can look at the comparative valuations to check whether or not the valuations of the company are in line with those of its peers.
Main risk factors: Investors can determine risk factors from the DRHP. Reading the risk factors is essential in determining if there are any major concerns or risks associated with the business. Sometimes there are certain disputes and liabilities, including contingent liabilities, which can pose a threat to the company’s future business prospects.
Investor investment horizon: An investor must have a clear investment horizon. It should be made clear whether she plans to invest in the IPO to make a quick profit on the day of the listing or whether she wants to hold the shares longer. Because a short-term strategy would depend on current market sentiment, while a long-term strategy would depend on the fundamentals of the company.
Additionally, an investor should do their own part of the research. If she believes in the long-term growth potential of the company, only then should she consider investing in the IPO. Don’t value an IPO on the basis of the gray market premium. IPOs can sometimes mean great opportunities to buy a stock at a price you might call a steal. So if you come across a business that is worth less than its real value, you should definitely grab this opportunity. However, you should only invest in an IPO if it is aligned with your financial goals and risk appetite.
The stock market is all about timing – when you enter the market and when you exit. Sometimes the timing is right on an IPO and sometimes it’s better to wait. Make a decision based on the level of risk you can take and the quality of the company’s fundamentals versus its valuation. Be skeptical, when it comes to the IPO market, a skeptical and informed investor will likely fare better.
(DK Aggarwal is the CMD of SMC Investment and Advisors)