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5 key factors to look at while investing in IPOs

5 key factors to look at while investing in IPOs

By CNBCTV18.com Contributor Mar 22, 2021 10:17:29 AM IST (Updated)

There are several factors that you must consider to ensure that your IPO investments profitable rather than being counterproductive.

Do you want to know an interesting fact? Out of the 15 mainline IPOs launched in 2020, 14 stocks are currently trading above their issue price. In several cases, the returns are more than 200 percent and even 400 percent in some. 11 stocks started extending gains from their listing day with 6 stocks giving a return of more than 70 percent on day 1.

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However, IPO investments are not a piece of cake. There are several factors that you must consider to ensure that your IPO investments profitable rather than being counterproductive.
Here are 5 key factors to mull over while investing in IPOs:
Conduct Detailed Research
IPOs are the first time that a particular company is getting listed on an exchange. Post listing companies are required to report their key financial figures on a quarterly basis. However, the information before a company ‘goes public’ is not easily available. All of the company’s relevant figures should indeed be there in the DRHP or Draft Red Herring Prospectus. Just keep in mind that such drafts are created by the companies themselves with the sole purpose to raise funds. It’s not done by an unbiased market entity.
So, you must conduct thorough research and find as much as you can about the company, its promoters, their criminal records (if any), financing, competitors, media coverage, and how well its industry is faring at large. In other words, make your research as in-depth as possible if you wish to make decent returns in an IPO.
Focus on valuations
In their rush to receive an allotment, it is observed that a lot of investors don’t pay much attention to the valuation of a company or its fundamental analysis. However, there aren’t many data points to conduct fundamental analysis for a company going public other than whatever is provided in the DRHP.
Companies going public typically offer stocks demanding rich valuations from their investors. You can always refer to its peers or the general industry trend to get an accurate idea about it. If a company going public is the first of its kind, then it becomes even more difficult to a thorough competitive analysis.
Monitor QIB participation
Any company going public makes special pitches to QIBs or Qualified Institutional Buyers. QIBs are SEBI-registered financial institutions, banks, mutual funds, and FIIs (Foreign Institutional Investors) that typically invest money on others’ behalf. Being a party to this process while also having a dedicated network to gauge the stock’s potential, the QIB participation is often considered by many to be a barometer of the stock’s future performance.
However, you must not singularly rely on this figure as QIBs can also have biases. For instance, out of the companies listed last year, the only stock that is currently trading below its issue price received an oversubscription of nearly 10 times by the QIBs. If you consider such oversubscriptions to be a guarantee of returns (or underperformance) in the long haul, you might find yourself in a spot at a later date.
Read the DRHP thoroughly
It is mandatory for all companies going public to give a detailed overview of their business operations, revenues, assets, liabilities, market landscape, and how they intend to use their raised capital in their Red Herring Prospectus. The investors have to be briefed about everything so that they can make informed decisions.
Though there are biases in RHP as well, you can always get key takeaways if you have an eye for details. Pay special attention to factors such as historic performance and how the company plans to use its funds. If it claims R&D or business expansion as its intended purpose, it’s a good sign as it might lead to future growth. But if the fundraising initiative is to pay off the liabilities, it is better to do a more detailed analysis of the company’s balance sheet and leverage.
Leverage Technology
Given the sheer dynamism that prevails in an IPO and the in-depth analysis that needs to be done, it’s preferable to let someone who can do the job while leaving less scope for errors. Today, there are investment recommendation engines in India that extend benchmark defying results by analyzing more than 1 billion data points. The good news is that they also extend IPO-centric advisories. You can count on them to understand which IPO to participate in and which one to give a miss.
As much as lucrative IPOs can be, the risk factor associated with them is also something that you should stay cautious of. Just keep the above-mentioned factors in mind. They will ensure that IPOs are always gainful opportunities for you should you receive an allotment.
The author, Jyoti Roy, is DVP- Equity Strategist at Angel Broking Ltd. The views expressed are personal
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