From time to time, companies need funds to expand their business and IPO or initial public offering is a way to source these funds from public investors. The capital hence raised by the sale of shares or equities fuels business expansion, repaying loans and debts and enable easy trading of existing holdings. The investors, in turn, become a part of the business, thus reaping rewards (dividends) in proportion to their investments, as the share price increases.
IPOs are attractive for investors owing to the common belief that stock prices shoot up after an IPO and hence it presents a great opportunity to “buy low and sell high”. This belief is the reason many investors rush to subscribe to such stocks at a reasonable price. While IPOs certainly have attractive prospects, there are certain things that investors must keep in mind before taking the plunge. Let’s see what they are:
Know your investment objectives: First things first, it is extremely important to know your risk profile and investment objective while going for an IPO. Understand your intention. There is a lot of hype created when a company goes public and investors rush to subscribe based on that. You may feel left out and decide to invest based on peer recommendation or the fear of missing out. However, these are not the right reasons to invest. If you have been following the sector and the company’s growth closely and truly believe in the potential of the company based on the fundamental analysis, should you consider investing in the IPO. Conduct thorough research about the company: It is a little tough to get information about companies that have decided to go public and hence it becomes all the more important for you to dig deeper. The first thing to do here is to read the prospectus of the company thoroughly. The prospectus is a document that contains details about the company’s financials over the years, the reason behind issuing IPO, promoter details, dividend policy, offer information, details about the management, regulatory and statutory disclosures, etc. The prospectus hence is a good starting point while researching about the company.
Apart from this, search online for media reports of the company were there any cases of defaults or issues in corporate governance, and how has it performed compared with peers. While this may seem like a time-consuming affair, do not bypass this step by just reading the prospectus. You may unearth some vital information that might indicate the company’s prospects are not as bright as being projected and hence this may not be a suitable investment opportunity for you. So do your homework well.
Take a look at the valuation: This may seem tricky for retail investors but is an important aspect that shouldn’t be overlooked. To begin with, see how the valuation of the company fares as compared to existing companies in the same industry. You can employ techniques like price to earnings ratio, price to book ratio and return on equity judge better. Know that backing does not guarantee returns: More often than not, investors are tempted to buy the IPO based on the list of investment banks or major stockbrokers that back it. However, their reasons could be based on different calculations. Stick only to the fundamental information that you have collected based on your research and evaluate the company’s growth prospects before taking a call.
To sum up, investing in an IPO should be based on your investment objectives and risk profile, backed by thorough research on the fundamentals. Don’t be tempted by the marketing efforts that go into the IPO process, be sceptical and well informed and take a long-term perspective while taking investment decisions. An IPO which is fundamentally strong will do well irrespective of market trends and reward investors who have invested for the long run.
Harsh Jain is COO and Co-founder of