Initial Public Offerings: How to find the right IPO to invest in

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February 23, 2021 1:45 AM

For every high-profile IPO which provides significant gain on its day of listing, there are many newbie shares that disappoint investors as the long-term performance of IPOs is underwhelming

Further, around 83 companies from sectors such as steel, cement, hospital, hotel, etc., have scheduled their IPO in the remaining part of the year. Let us see what investors should look for while choosing which IPO to invest in.

The stock market’s powerful rebound from last year’s pandemic-related plunge have put investors in a buying mood. Dalal Street is full of energy as initial public offerings (IPOs) are hot again. A mixed bag of companies ranging from young ones, some of them yet to post profits, to ones with huge net worth such as LIC are selling shares to the public for the first time. Further, around 83 companies from sectors such as steel, cement, hospital, hotel, etc., have scheduled their IPO in the remaining part of the year. Let us see what investors should look for while choosing which IPO to invest in.

Avoid buying hyped shares
For every high-profile IPO which provides significant gain on its day of listing, there are many newbie shares that disappoint investors as the long-term performance of IPOs is underwhelming. This may also be due to expensive valuation that tends to limit future gains. Investment bankers who underwrite IPOs set the offer price and dole out most shares at that price to their best customers like hedge funds and mutual funds. So, most investors may not get the shares allotted on IPO until it starts trading in the secondary market. Thus investors cannot benefit fully if at all from the gains of the first few days. Further, it is empirically proven that investors could earn better returns by investing in a broad stock index than owning a portfolio of recent IPOs.

Strategies in IPOs
This year’s IPO pipeline seems to be robust and includes many strong companies. There are many strategies one can practise for investment in IPOs. First, if you are not getting the shares allotted in the IPO at the offer price, avoid buying the shares on the day of its listing. Instead, consider a wait-and-watch policy. If you are confident that a newly listed company has a bright future, consider buying on a dip or even after a big drop. Investors may also wait till a firm proves its worth and its sales and earnings growth become sizable and sustainable. Another way to gain exposure to IPOs and reduce individual stock risk is by investing in broadly diversified and low-cost exchange traded funds that own IPOs firms as a tactical addition to your existing portfolio.

Read the fine print of DRHP
The Securities and Exchange Board of India (SEBI) mandates all companies who want to go public to file a draft red herring prospectus (DRHP) with them. This document is the best source of not only financial information but also about other non-financial information about the company. Although tedious and time consuming, it is always advisable to read the fine print provided by the company as it provides important information regarding the company’s business, summary of financial statements past and estimated, capital structure, objects of the issue, management views, etc.

Investors should also know about the promoters and their credibility, management team and their qualifications, etc. The prospectus will provide investors with all necessary information about the IPO, and it will help to decide if the company is worth investing in or not.

To conclude, investors should not think of IPOs as get-rich-quick instruments as the most hyped IPOs sometimes fail to deliver.

The writer is a professor of finance & accounting, IIM Tiruchirappalli

IPO checklist
If you are not getting the shares allotted in the IPO at the offer price, avoid buying an IPO on the day of its listing
If you are confident that a newly listed firm has a bright future, buy on a dip or even after a big drop
Read the DRHP fine print filed by the company
Investors could earn better returns by investing in a broad stock index than owning a portfolio of recent IPOs
Around 83 companies plan to go for their IPO during the remaining part of the year

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