Planning to invest in an IPO? 5 crucial pointers to keep in mind

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November 15, 2021 1:05 PM

It is wise for investors to take enough precautions while investing in IPOs as at times such investment could be riskier than perceived.

If the business looks too risky as per the advice of market participants and does not match well with your risk-taking ability, it is better to avoid investing in IPOs.

Indian stock markets have recently witnessed a flurry of initial public offerings (IPOs). With stock indices trading at an all-time high, such a frenzy of new issuances is expected with more IPOs lined up to hit the market. However, every new entrant in the capital market should be assessed well on various factors before investing as they may not be as promising as being portrayed by market intermediaries.

Therefore, it is wise for investors to take enough precautions while investing in IPOs as at times such investment could be riskier than perceived.

Before going ahead, let’s first understand what an IPO is.

What Is An IPO?

An initial public offering is a procedural process of turning a privately held company into a public one by raising capital from the stock market upon issuance of shares to investors. IPOs allow private firms to raise funds for their upcoming projects or expansion while making the company open to public scrutiny. Listing of the shares on the stock exchanges helps the company get a fair valuation of its worth. Such offerings enable public investors to participate in the company’s future growth story.

Having said that, it is important to note that not all IPOs turn into a successful one. There have been several such issuances in the past which couldn’t succeed while many others did quite well and kept adding value to investors’ wealth. Thus, investors need to do a good amount of due diligence while choosing to invest in IPOs.

Here are 5 precautionary measures one should undertake while putting in money in IPOs.

1. Read DRHP Thoroughly

The Draft Red Herring Prospectus or DRHP of a new entity offers a detailed insight into the company that is coming up with an IPO. Filed with the securities market regulator Securities and Exchange Board of India (Sebi), the DRHP is an important document that entails crucial details about the company, including its business, past performance, assets and liabilities, why and what it intends to do with the proceeds raised through IPO, and the possible risk factors that could impact the company’s performance, and thus, the share prices going forward. You should not skip reading it thoroughly before deciding to invest as the DRHP provides critical information that can help you understand the business better and make you an informed investor.

2. Purpose Of Capital Raised

The ‘Why’ factor about the need for capital by the company should always be given utmost importance. If the company is burdened with debt and mentions in the DRHP that proceeds will be used to pay off the existing debt, investors should be cautious of such issuances. However, if the utilisation will be done for a mixed purpose of debt payment as well as expansion, one may consider investing. If the company already has a growth chart of profitability with a reasonable cash balance and wants to put the proceeds solely for expansion to scale up size and reap upcoming benefits, the issuance may be a compelling opportunity to invest.

3. Know the Promoters

The people who are running the show in a company should be given a close look. This includes the firm’s promoters and other key officials in the management. Since these personnel are the driving force of the company, the growth prospects largely depend on their ability to make the right business decisions. An investor should take note of the number of years the key management officials have spent with the company.

4. Potential growth drivers

Factors like the company’s positioning in the sector it operates in, its market share, accessibility and visibility of its products, geographical spread, expansion plans, estimated profitability, supply chain, ability to handle crisis, and efficiency could be among the various growth drivers which would decide the upcoming business prospects.

5. Risk Factors

Attention must be given to the risk factors mentioned by the company in its DRHP. These act as filters and can make or break the deal when it comes to investing in IPOs. Ranging from legal litigations to weather calamities to from policy-related changes to interest rates, risk factors could be many, which can potentially hamper the company’s future growth prospects.

Finally

Just like any other investment, assess your risk-taking capability before investing. You should invest according to your risk appetite. If the business looks too risky as per the advice of market participants and does not match well with your risk-taking ability, it is better to avoid investing in IPOs. Further, if the valuations on offer do not match up with the growth prospects, you should give it a miss.

Doing your own research is something you should consider for an IPO. Fresh issuances should not be taken as a quick money-making instrument. At the same time, it is equally true that you don’t need to invest in every IPO. It’s prudent to make decisions depending on how much risk one can take. Needless to say, an informed investor performs well in the long run.

(The author is CEO, BankBazaar.com)

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