An initial public offering (IPO) is a milestone that generally indicates that the company is growing. The IPO-bound company intends to fund its growth prospects by going public and raising funds. But IPOs can be misguided investments for a layman.
One cannot invest in an IPO just because it is a big name in the market. Positive media cannot be a base for investment. As a prospective shareholder, you should keep an eye on the IPO calendar and analyze the market to decide on the IPO investments. Investors need to understand the misconceptions and potential opportunities around the primary market.
An informed decision can make IPO investing profitable. You can make an informed investment decision by considering differentiating misconceptions and reality. Here are the key points to consider before IPO investing:
A company going public is not necessarily financially stable
The stability of a company’s financials is uncertain. Its financial fortune is often contingent on many factors including, government regulations, tariffs, and its stage in the economic cycle. Such factors can favour a company or can work against it. Investors interested in IPO investing should check how well it can survive in adverse economic situations and maintain its abundant financial situation. Investors can look at its fundamentals and management. Management is the soul of a company and needs to be efficient to support a company’s growth.
Check for Promoter Intentions
The upward force of the markets has attracted considerable investor interest from both retail investors and institutions. But investors should consider if an IPO is really concerned about raising funds or if it is an exit route for promoters. The offer for sale (OFS) in an IPO should not be outstripped by fresh capital. OFS means selling existing shares of investors and promoters of the company. Investors must check how much interest the promoter dilutes. Knowing if the promoters are exiting the company through IPO is necessary. If yes, it may be an unfavourable IPO for investors. Following laws, promoters must hold a minimum of 20% of the post-issue capital. If they dilute their stake significantly, it shows they do not have trust in the company’s growth. Like mutual fund investing, you should know where IPO funding will be deployed by the company.
Know if it is an unnecessarily hyped IPO
Being an informed investor, you should understand that IPOs are not miraculous money-making investments. However, IPO investments can profit more than common stock investing. It can bring an opportunity for retail investors to gain significant returns on a single transaction in the long run. But make sure it is not a hyped IPO by merchant bankers. IPOs should not be priced in such a manner that there is little left on the table for retail investors. Over-hyped public issues through misleading advertisements and media reports can create misconceptions about IPO investing. However, SEBI has a set of self-regulatory measures of due diligence.
Check if IPO stocks are priced
IPOs of popular companies can overprice their shares than they are worth. For fair pricing, investors can go through a competitor analysis using Price-to-Sales and Price-to-Earnings ratios. A lower ratio than its peers shows correctly priced shares. However, there can be times when the shares are priced higher because the company is actually performing well in the industry. You can review the company’s history and prospects to comprehend its performance.
Underwriters or brokers associated with the IPO can help you know the company’s worthiness for investing. Prominent underwriters consider quality associations as they are selective in underwriting an IPO with worth.
Also, going through the company’s prospectus is inevitable as it consists of all information like company performance, growth prospects, and risks. Like many investors, you can prefer to wait till the lock-in period gets over to purchase IPO stocks. It will help you analyse the IPO profitability concerned by its early volatility. Corporate shareholders are allowed to sell their IPO stakes only after this period.
Thus, IPOs appeal to most stock market investors because good returns can be expected with the growth potential of the IPO-bound company. Investing in IPOs based on in-depth research is a good idea to earn significantly from listing gains or in the long run.