How New Investors Should Approach the World of IPOs

Well, it turns out that’s true not only for India, but the rest of the world as well.

So far in 2021, a total of 1,821 IPOs have been completed worldwide. Of that number, 106 were released in India.

By the end of 2021, another 10 people are expected to be listed on stock exchanges in India. The total funds raised through these IPOs are expected to reach ??1 ton.

The Indian IPO market in 2021 is not only different because of the number of IPOs but also because of the huge participation of retail investors.

In fiscal year 2021, a total of 14.2 million new investors participated in the stock markets. In the first quarter of fiscal 2022 alone, 7.1 million new retail investors entered the financial market.

For a new investor, IPOs look extremely promising. The SEO payouts are huge and provide a great opportunity to make money in the short term.

But here’s something you need to know before investing in an IPO, whether you’re a first-time investor or not.

IPOs can be very risky.

With the risks in mind, here are a few things you can consider before investing in an IPO.

# 1 define your goal

Before investing in an IPO, it is important to define your goals.

Applying for Listing Gains or looking for a potential candidate for your long-term portfolio?

Some IPOs can give great listing gains, while others may be listed low initially, but can be a great choice for a long-term portfolio.

Take the case of Zomato. It gave almost 65% return on the day of the listing. For investors looking for short-term gains, this would have been a great opportunity.

However, since its listing in July 2021, Zomato’s shares have fallen. They only increased by 12%.

On the other hand, shares of Anupam Rasayan India listed at nearly 5% off its issue price in April 2021. However, the company’s shares have risen 70% in the past eight months.

You can’t predict whether an IPO will be listed with a premium or a discount. It depends on several factors.

But if you are a first-time investor, it is always best to invest for the long term. This will help you overcome short term volatility.

# 2 understand the business

Warren Buffett said, “Never invest in a business you don’t understand”.

For a listed company, the sources of information are endless. But for a company that is not yet public, the Red Herring Prospectus Project (DRHP) is the gold mine of information.

By reading the DRHP, you can identify the strengths, potential opportunities and risks of a business. You can also assess the company’s performance in the medium and long term.

If a company’s business model is beyond your understanding, then it will be difficult to track its progress.

FMCG companies such as Nestlé have a simple business model that can be easily understood. They earn income by manufacturing and selling consumer products. You can easily follow the growth of these companies.

However, new age tech companies like Zomato have complex business models.

Zomato takes advantage of technology to deliver food to your doorstep. It also offers other services such as a list of restaurants and their menus for dining out.

The backend processing that takes place in terms of technology and workforce coordination can be confusing for some to understand. Therefore, it is difficult to follow the growth of these companies.

Don’t invest in a business that you find confusing.

# 3 How will the business use the funds?

Each company should disclose why it wants to go public and how it will use the funds.

You can find this information in DRHP in the “Problem Objects” section. Here the company will explain in detail how it plans to use the funds.

Why do you need this knowledge?

There are two reasons …

First, it’s your money. So you have the right to know how it will be used.

Second, by knowing how the business will use the funds, you can determine the sustainability and viability of the business.

Try to assess whether the company is using the funds to increase profits or not. If so, you can evaluate it further to see if it is a good investment.

# 4 Why are existing shareholders selling their shares?

When a company goes public, it is often because the existing shareholders intend to sell their shares rather than raising funds through a new issue.

In such a case, all profits go to the promoters and not to the company. Hence, you need to be extremely careful before investing in such companies.

You may start by asking yourself why are existing shareholders selling their shares?

Of course, they could reserve profits. But you can still get an idea if they come out to profit from a high valuation.

Take Paytm for example. Over 50% of the funds raised by the company were raised through an offer to sell by existing shareholders.

The market also thought the show was overpriced. This resulted in the listing of the company’s shares at a discount from the issue price.

# 4 look at company finances

This is the most important section for any business.

In the DRHP, you will find information on the profitability and financial situation of the company in the “Financial information” section.

Why do you need to consult the financial statements of the company?

By studying the financial statements, you can see the company’s turnover, expenses, and profits.

A profitable business is more likely to survive in the long term than a loss-making business. If a company’s financial profile is strong, stocks will automatically perform well on the stock market.

Take Paytm for example, the company has consistently reported losses over the past five years. As a result, the company’s shares have performed poorly despite being a popular brand.

The popularity of the brand does not determine its performance on the stock market. Its fundamentals do.

Look for a company with solid fundamentals and a solid financial profile in which to invest.

# 5 Reviews

You may have read analyst reports that say, “The IPO is valued at ??200 m ‘.

What is that ??200 meters?

This is the value of the business. A business hires experts to assess their business based on its performance and other factors.

But what does this mean for investors?

In value investing, there is a concept called intrinsic value or real value. This measure determines the real value of a business. Based on intrinsic value, you can determine whether the IPO is overvalued or undervalued.

An undervalued stock means that it is underestimated by the market. In other words, the company’s shares are trading below their real value.

This means the stock has good upside or upside potential and minimal downside risk. It is better to invest in an undervalued company because it offers investors a margin of safety.

# 6 Management context

It is very important to check the background of the people who run the business. The promoters and the management are the main pillars of the company. They are the ones who will drive the business forward.

A business with a strong management team indicates better prospects for future growth.

Take the case of Hindustan Unilever.

The company is known for having a strong management team that follows good corporate governance practices.

The same can be seen in its ever increasing share price.

In contrast, companies like Satyam have seen their share prices plummet due to fraudulent management.

To conclude…

Investing in IPOs is risky business.

Thirty of the 106 IPOs listed to date have been listed below the issue price. Many have done well as well, but you never know how the company’s shares will perform in the long run.

Take the case of ICICI Lombard. It posted a 2% discount. However, in the past four years, the company’s shares have doubled.

If you had exited the stock on a trading day you would have suffered a loss and also missed out on a huge profit in the long run.

In a volatile IPO market, new investors end up making the wrong decision in the heat of the moment. Don’t let this happen to you.

Participating in the stock market can be very exciting. But don’t let your emotions get in the way of your decision making.

When investing in an IPO, it’s always best to do your research and proceed with caution.

Good investment!

Disclaimer: This article is for informational purposes only. This is not a recommendation for action and should not be treated as such.

(This article is syndicated from Equitymaster.com)

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