Before investing in an initial public offer, check the company’s financials and other important credentials
By A P Singh
Many companies are coming up with their Initial Public Offerings (IPO) these days, but you should be cautious while selecting the right IPO for your investments. Investors may think that investing in IPOs could give them great gains on listing but that is not always true. There were IPOs in the past where investors had suffered losses on the day of listing or afterwards. Finding a good IPO to invest in is not impossible but is undoubtedly a difficult task and hence requires detailed and extensive research.
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A profitable IPO comes with certain characteristics that need to be understood by the investors. Before you invest your money in the IPO, it is important to take a careful look at the company credentials. Besides checking the finances of the company (at least three years), prospective investors must also look at other indicators for identifying the IPO for their investments. Let us understand six different factors that should be considered before investing in an IPO.
DRHP – An investor’s Bible
One of the most important repositories of information about the company is the ‘Draft Red Herring Prospectus (DRHP)’. Companies are required to file their DRHP with the Securities Exchange Board of India (Sebi) while floating an IPO. Analysing this document would give you financial and other information about the company like the quality of management, its history or work experience, qualifications and projects handled, etc. It will help you in identifying the risks and opportunities involved with the firm.
Subscription by QIB
Another way of selecting an IPO for investment is to look for the subscription in its qualified institutional buyers (QIB) category as that gives an idea of the quality and pricing of the issue. These institutional buyers have better access to data that individual investors may not have. They invest in IPOs after extensive research and will not put their money in an IPO which is likely to generate negative returns. A very low level of subscription would mean institutional investors do not see the issue as a strong proposition and such issues should be avoided. If the QIB category is oversubscribed, then you can proceed. A very high level of oversubscription would also mean huge retail subscriptions and chances of allotment would be less which may make the entire exercise futile.
Take a look at the valuation
This may seem tricky for retail investors but is an important aspect that shouldn’t be overlooked. Ratios like price-to-earnings and price-to-book-value should be taken into account and should be compared with its peers for the right valuation. If the price is overpriced in comparison to the shares of peer companies, then the investment should not be made.
Company’s financial performance
One should also check the financial performance of the company on a year after year basis. If the company’s revenue and profits are growing, it is an indication that the firm is growing well and has growth potential. However, if the performance of the company is lower than the industry, it is likely an underperformer. This is when you should look for better investment options.
Understand risk, future prospect
Understanding the risks associated with each business is an important step before investing. The current market environment, number of competitors, and quality of the product or service will all play an important role in this. Future prospects of the company should also be checked if you are investing for the long term through IPOs. You can select companies with good and innovative business models that can sustain in the future.
Understand the business
As a general rule, avoid investing in a business you don’t understand. You should invest within the circle of your competence. This is because a thorough understanding of a business can help you make better decisions. It is always better to do your homework instead of relying on mere hearsay, tips, or rumours in the market.
The writer is director, Amity School of Insurance, Banking & Actuarial Science, Amity University