Investing in IPO requires lots of fast decision-making. A good investor can learn to navigate the stock market quickly. Opens digital or trade bank account. But from there, the investor could go in any direction as well. There are numerous options given that the stock market has unlimited possibilities. Investing in IPO is can one of the profitable decisions if taken correctly.
We all witnessed the booming trend of investing in IPO in 2021. With many big names that have recently entered the market, experts suggest that the number of IPO is going to be much higher in 2022.
In such a scenario, any smart person would think of investing in an IPO. If you are one of them, you must read this blog as it contains all the crucial aspects that all individual investors should know before investing in IPO. However, let us first understand what an IPO is:
What is IPO?
When a company decides to raise capital or become a publicly-traded company, they have to list their shares in the open market through any of the stock exchanges. This listing is called an IPO. In other words, Initial Public Offering (IPO) refers to the initial sale of shares of a privately held company.
A company usually announces an IPO to raise capital but there could be several other reasons as well, like:
- Publicity and building brand recognition
- Gaining trust and increasing credibility
- Maintaining price transparency among shareholders
- Creating exit opportunities for all initial investors
Know about IPO in detail: Everything about IPO
11 Things to Consider Before You Invest in an IPO
India is witnessing the busiest IPO season as every company is trying to raise funds through IPO instead of turning to financial markets or arranging borrowed funds. In such a scenario, there is no doubt that every person would want to extract the benefits through investing in IPO.
However, this is also the time to exercise caution while you decide in investing in IPO shares of any unlisted company. So, here is the checklist that you need to tick off before bidding on any IPO listing on the stock exchange:
1. Read the Draft Red Herring Prospectus (DRHP)
A document that contains all the details regarding the IPO launch so that the public investors can make an informed decision while buying IPO shares. A DRHP entails the following details about the companies initiating IPO:
- Purpose of raising equity capital
- Details of the balance sheet
- The expense of the Promoters
- Company’s Business Plan
- Financial details
- Copy of the underwriting agreement (including commissions and discounts of the underwriters)
- Name and address of all the officers, directors, underwriters, and stockholders who possess 10% or more of the currently outstanding stock
- Legal opinion on the listing
Sample DRHP of Nykaa: Download
In most cases, a DRHP is prepared by investment banks where they share the price band that has been allocated for the shares. (A price band specifies the upper and lower price limits of the stocks. The final price is determined from within this range depending on the demand for the shares.)
Know about: Financial market intermediaries
Reading this document should be the first step of your investing in IPO process. If you will read this document carefully, you will understand what the company stands for and what they wish to achieve in the next few years.
Just reading this document will also help you become an informed investor and make the right choice.
2. How Proceeds from the Primary Market Will be Utilized
Investing in IPO is becoming more like a trend. Being a part of the trend at the initial stage is often fruitful, but investors have to be careful because a simple mistake will blow up their savings.
It is, therefore, important for you to do proper research and get a clear understanding of how the company is planning to utilize the proceeds from the IPO investments.
This will help you to not only analyze their future growth potential but also guess whether the investing in IPO will be successful on the stock exchange or not.
3. Research to Understand the Business of the Company
If you think that understanding how a company will utilize the capital earned through the initial public offering is enough, think again! Don’t you think that a smart investor should also understand the business of the company before investing in IPO?
You would not want to accumulate losses through your investment even if your risk appetite is high. After all, an investment turns out to be profitable only if the investors have considered each and every aspect minutely.
To know more about the business of any of the companies, all you have to do is to, log on to the website of the company. This will tell you all that you need to know about the business of the company.
Thereafter, interested investors can also visit the social media handles of the company and read a few customer reviews.
4. Check Promoter and Management Background Along with Past Performance of the Company
The stock market is highly speculative and you cannot base your investment decisions solely on the business operations and their plans to use the IPO funds. Investors have to dive deeper and check the background of promoters as well as the management, be it a book-building offering or a fixed-price IPO.
If the backgrounds of promoters or the management are not commendable enough, it is better to pass the opportunity. However, if you think that the opportunity is too good to overlook, we suggest the “getting in and out quickly” strategy to avoid any losses.
Moreover, it is also suggested to have a look at the performance of the companies in the past few years. This will give you a clear perspective of what kind of growth you can expect from these companies.
5. Analyze the Potential of the Company in the Stock Market
Once the initial public offerings are sold in the primary market, the shares of the private company enter the secondary market of the stock exchange. It is in the secondary market that investors can reap the benefits of their IPO investments.
Moreover, if you wish to hold the IPO shares for a longer period of time, you must also analyze the long-term potential of the public company.
6. Figure Out the Key Strength and Strategy of the Company
Institutional investors give utmost importance to figuring out the key strength and strategy of the company initiating public ownership to attract potential investors. You can easily get an idea of the key strengths and core strategies of a company by following company insiders or through your brokerage firm.
If the interested investors bid for an IPO without considering these aspects, they are more likely to be unaware of the bigger picture. For example:
When investors do not know the key strength and strategy of the companies, they are more likely to do panic selling as soon as the IPO price dips during the secondary offering in the market.
7. Check Financial Health of the Company
While an investor is considering investing in an upcoming IPO, it is always recommended to check the financial health of the company. Therefore, investors must analyze the top-line and bottom-line growth along with the potential of the secondary offerings in the open market.
8. Compare with Peer Groups
We are not suggesting you only compare the lengthy document, issue price, and the minimum number of shares that companies set. Instead, we are also asking you to compare the company that you wish to invest in with other companies that offer similar services to get an informed idea.
9. Understand the Risk Factors
When an investor plans to invest in an initial public offering (IPO), it is crucial to set the risk tolerance at a high level. There is no doubt that an IPO offers a lucrative opportunity but, at the same time, there is a high risk that you might lose money.
Companies initiating IPO are not always interested in raising capital. Their IPO process might be targeting a different outcome.
10. Ascertain Your Investment Purpose
Before you even decide to invest in an IPO, you must pen down all the investment objectives in your mind. It is important that you should know the purpose of your investment.
If you are looking for short-term gains, you must purchase shares in an IPO and sell them as soon as they are listed on the stock exchange. However, if your objective is to make long-term profits, it is better to hold the shares until all the financial metrics are telling you otherwise.
If your objectives are not here most of the time you will not be able to take the right decision at the right moment.
11. Big Name doesn’t the Guarantee for a Big Return
Contrary to common belief, a big name can’t give you the guarantee for big returns. The most recent example to prove this fact is the PayTM IPO. So, don’t just go for the IPO because the brand has a huge presence in the market. Check all the factors on this checklist before making a choice.
Pros of Investing in IPO
- First Mover’s Benefits: When you are investing in an IPO, you get the shares at a very low price. The best part is that you can get lucrative returns when the shares are traded freely.
- Long-term Benefits: If you decide to hold the shares for a longer period of time, the prices of shares might get higher increasing your investment gains in the long term.
- Price Transparency: Raising stocks in an IPO offers price transparency, thereby, reducing confusion and resentment among shareholders.
- Better Earning Opportunities: IPOs offer better earning opportunities to an investor because, unlike other investment options (like a mutual fund), investing in an IPO gives you the choice to get quick returns.
Read more: Importance of investing
Cons of Investing in IPO
- Time-Taking: If an investor is more interested in trading shares, he/she will find IPO as a time-consuming process. It is because the time gap between the application and allotment of shares is generally high. Plus, the applicant has to wait for a few more days to sell the shares.
- Risky: As discussed earlier, investing in the very first offering is risky because the prices could go either way when the shares are traded freely.
- Privacy: An investor has to share a lot of information while applying for an IPO, including bank account numbers and several other details. Thus, the privacy of people, investing in the IPO, is highly compromised.