There may be several reasons why a company goes for an IPO. It can be for funding its business operations, repayment of the debt, dilution of shares, etc. Similarly, your purpose of investing in an IPO may be different – listing gains or long-term investing. Whatever may be the reason for you, there are certain things that you should consider before investing in an IPO. The article highlights the Things to Consider Before Investing in IPO in detail.
11 Things to Consider Before Investing in IPO
Following are Things to Consider Before Investing in IPO:
1. Draft Red Herring Prospectus (DRHP)
A corporation files the Draft Red Herring Prospectus with SEBI when it intends to raise capital by offering its shares to the public.
The document mentions how the company intends to use the funds obtained from the public and the potential risks for investors. Therefore, investors must review this document before investing in any IPO.
Recommended Read: What is Red Herring Prospectus?
2. Reason for a Public Issue
You need to understand how the company intends to use the capital that it plans to raise through the Initial Public Offering. Check to see if the company intends to repay its debt or plans to raise capital for partially repaying debt, developing the business, or utilising the funds for corporate reasons.
The reason for the issue highlights how the company plans to spend the funds, which is a positive indicator for investors. Thus, understanding the reason for the issue helps you understand what the company plans to do with the money.
Recommended Read: Why Do Companies Go Public?
3. Business Model
Before participating in a company’s Initial Public Offering, investors should thoroughly understand the business concept.
Next, you should try to identify the new market opportunities upon understanding the business concept. The size of the opportunity and the company’s ability to gain market share can significantly impact the company’s growth and shareholder returns. Thus, it is important to understand and analyse the potential opportunities.
If the company’s commercial activities are unknown, then you should avoid applying for the initial public offering (IPO).
You can read our article on Upcoming IPOs in India 2023
4. Promoter and Management Background
Promoters and the management play a key role in the company’s performance. A strong promoter and management background will positively impact the company’s operations. Thus, the management and promoters are considered the backbone of any company.
Investors should evaluate the company’s promoters and managers, as they significantly influence all of its operations and functions. The company’s management plays an essential role in propelling the business forward. The qualifications and the experience of the company’s top management might provide insight into the company’s work environment.
5. Company’s Strengths, Weaknesses, Opportunities and Threats
Before investing in a company’s Initial Public Offering, you should conduct a Strength, Weakness, Opportunities and Threats (SWOT) analysis.
The DRHP document comprises the company’s primary strengths and weaknesses. Analyzing the document, you should determine the company’s standing in the industry in which it operates. Furthermore, evaluate the future possibilities of a firm and read as much as possible about the company’s business and its proposed strategies.
You should also consider the company’s market potential, i.e. opportunities and threats.
Investors should also examine the company’s valuations. The offer price may be undervalued or overvalued depending on the company’s sectors and its financial parameters. Thus, you can value the company and verify the valuations if you have financial knowledge and expertise.
7. Company’s Health
While considering an IPO, it is necessary to check the company’s financial performance over the past several years. This will help you determine how the company has performed over the years and whether the company’s sales or profit is regularly expanding.
If the company’s income and business grow, investing in its initial public offering can be a wise decision. On the other hand, if the financials look muted, it’s better to avoid investing in such companies. Thus, a company’s financial health is a vital parameter to consider before opting for an IPO.
8. Investment Horizon
Before investing in a company’s IPO, an investor should have a clear investment horizon.
You must know your purpose of investing in the IPO. It may be solely for trading purposes on the day of listing or long-term investing.
If the reason is listing gains, then it depends on the present market conditions. However, if the objective is long-term investments, then it depends on the company’s fundamentals.
Explore: What is IPO Listing?
You should also analyze the performance of the company’s competitors. The DRHP document comprises both financial and valuation-based peer comparisons. You must examine the comparative values to determine whether the company’s valuations are comparable to those of its competitors. And analyze the position of the company against its peers.
The DRHP enables you to identify risk factors. It is essential to read the risk factors to determine whether there are any big worries or risks related to the business. Occasionally, certain lawsuits and obligations, particularly contingent liabilities, can threaten the company’s future business prospects. Thus, make sure you analyze the risks of the company.
IPO grading is the grade that a Sebi-registered credit rating firm or agency assigns to an IPO. The rating of an IPO is also an essential parameter that you should consider. Generally, the higher the grade, the greater the likelihood that the IPO will be successful. However, there is no specific formula for this. In the past, even companies with high grades were required to withdraw their IPOs. While grades are a useful signal, they cannot be the sole parameter. You need to consider all the above parameters together.
Who Should Invest in an IPO in India?
If you are an investor who understands the business, company, or industry it operates in, you can consider investing in the IPO. Investing in an IPO is a risky option. The price movements are not certain. The company may list high listing gains or may list at a discount.
Investing in an IPO requires you to perform an in-depth analysis of the company, industry and peers.
Furthermore, if you are investing in an IPO only for listing gains, you need not worry too much about the company fundamentals or other parameters. However, if your investment objective is long-term, and you wish to hold on to the stock, you must carefully analyse the company’s financials, business prospects and valuations.
IPO investing is suitable only for investors with risk tolerance levels to absorb market volatility.