How To Find A Good IPO & When To Invest In It?

January 20, 2021

How To Find A Good IPO & When To Invest In It?


How To Find A Good IPO?

 With IPOs flooding the equity markets, investors are spoilt for choice. Knowing which is the best IPO to buy can be tricky. Here are some evaluation criteria to help you identify a good IPO to invest: 

1. Business strength

Thoroughly review the company’s business model, management credentials, and historical performance. A good starting point when evaluating the best IPO to buy is the red herring prospectus. All companies undergoing an IPO issue this.

It contains most of the information you need to evaluate the company. The company’s website, annual report, and media reports are other sources you can refer.

Invest only if you are convinced that the company has a strong business model, financial health, revenue potential, and management quality. Also, consider factors like the company’s position in its industry and its unique attributes that give it an edge over competitors. 

2. Growth potential

A strong track record does not guarantee strong revenue growth in the future. Since stock prices track future growth, the best IPO to invest in is one where the company has the strongest future growth potential.

Start your IPO investment analysis by evaluating the growth potential of the industry in which the company operates. Then, estimate how the company’s market share would grow over the coming years.

For this, you can use factors like how much the company is investing in technology, how is its innovation culture, what is it doing to expand its market, and how it is exploiting its identified strengths.

 If you think the company is doing well on all these parameters, you may go ahead and invest in the IPO.

 3. Promoter intentions

 Nobody likes to exit their company while it is growing and profitable. So, check how much interest the promoter group is diluting before investing in an IPO. The law mandates promoters to hold at least 20% after an IPO. But promoters of successful companies have generally held significantly more.

 If a promoter group is diluting its stake significantly, it can mean that the group no longer has faith in the company. It could also mean that it is not very keen on running the company for long, and may not give it the due attention. It could also be involved in some foul play.

 You can quickly judge the management’s intentions by looking at what they are drawing from the company. A company that pays fat remunerations and large dividends to the management is highly suspect. Especially if the management is also significantly diluting its stake through the IPO. It is best for you to stay away from such a company.

4. Use of proceeds

 You can find the intended use of the IPO money in the red herring prospectus itself. The best IPOs are ones where the funds will be used for growth-related investments, such as in new technology, entering new markets, setting up a new production facility, or acquiring other businesses.

 These investments can increase the company’s revenue and profits, resulting in higher stock prices and more dividends. Make sure that the company has a strong growth plan in place and its intended use of proceeds is in line with it.

 IPOs where the proceeds will be used to repay old debts, settling old claims, or making working capital-related investments may not be the best ones.

 5. Pricing

 Do not make an IPO investment just because the company is famous. The company’s brand name is just one ingredient that distinguishes the best IPO from others. Popular companies can price their shares higher than they are worth and have oversubscribed IPOs.

 You can estimate the fair price of a stock through a competitor analysis. Price-to-Sales and Price-to-Earnings are two of the most commonly used multiples for this.

 You can calculate these ratios by dividing the price of a company’s stock by its sales per share and net income per share respectively. Both these figures are given in the company’s income statement. If these ratios are higher than those of competitors, the stock may be overpriced. You should avoid such an IPO.

 Of course, there are times when the shares are priced higher because the company is actually better than its competitors. A thorough analysis of the company’s history and future prospects will tell you if this is the case.


When To Invest In An IPO?

Initial public offers (IPOs) are very popular among retail investors. But that doesn’t mean you bid for each and every IPO that comes in the market. There are a lot of factors you need to consider before investing in one. So, here are a few pointers to help you decide when to (or when not to) buy IPO stocks.


1.Go through the projected figures

The prospectus uploaded on Securities and Exchange Board of India (SEBI) website is a thick document filled with jargons. But that shouldn’t put you off. You can glean a lot of valuable information from this document.

 Check if the company plans is raising capital to expand operations and enter new markets. Go through the projected financial figures in the document. It is important because many a times companies can over-promise and under-deliver.

 2.Probable reason for going public

Look out for the company’s founders and initial shareholders. Check if the IPO is a reason for the initial investors to cash in and exit the company. This is another red flag because it simply means that original investors don’t have much faith in the growth of the company.

 3.Beware when the markets are at record highs

When the market is performing well, investors are highly optimistic. Everyone wants to be a part of the growth cycle. Every new IPO sounds like it is the next best thing. Unfortunately, this is not true. The dot-com bubble in the late 1990s was a prime example of such optimism.

 Tread carefully when the market is performing really well. Only seek out companies that have strong fundamentals and high growth potential in the future.

 4.Utilisation of funds

If a company is not able to repay its loans without issuing stock, it basically indicates there is something wrong with the company’s internal operations. Give such companies a short shrift.

 5.Sector performance

When you are planning to invest in an IPO, you shouldn’t view the stock in isolation. It is always better to understand the performance of the sector to get a better understanding.

 For instance, imagine the company belongs to the IT sector. You should analyse the performance of stocks of similar market capitalisation. How are stocks performing? What is their future potential? What are the threats and opportunities?

 The answers to these questions can help you get a better understanding of the competition and future growth prospects.


Tips and Strategies to Invest in IPO


Making money from IPOs involves certain strategies. If you get them right, you can make meaningful gains in the long run. Some IPO investment strategies that you must follow are:


1.Check the Performance of the Company

 Before IPO investment, it’s imperative to check its performance of the company in the long-term. Watch out especially if the company’s revenues have increased all of a sudden before the IPO. If the company has been growing decently over the years, in all likelihood, it’s a good firm.

 On the other hand, if the entity has been reporting poor numbers over the years, it’s advisable to give its IPO a miss.

 2.Find Out How Your Money Will be Utilised

 A sound IPO strategy involves finding out how the company will utilise your money. Go through the prospectus well to find out how the company plans to use the capital raised.

 Find out the company’s plan of action that could be developing new products, expansion, bettering infrastructure, etc. If the prospects look promising, go ahead, and invest.

 3.Check the Background of the Promoters

 One of the essential IPO buying strategies, you must check the background of the promoters of the company. Find out about their experience and see if they have a clean track record or not.

 Also, check out if the company has any record of payment defaults. It’s advisable to go for the IPO of a firm with a clean record and robust corporate governance.

 4.Zero-in on a Strong Broker

 Participating in a lucrative IPO involves zeroing in on an established broker. This is because it can be pretty tough to participate and get involved in an IPO that has sound prospects.

 However, things can be different if you have a reliable and sound broker by your side. Using their connections, they ensure that you get a decent allocation.

 5.Fill up the Application Form Carefully

 This is another crucial IPO investment strategy. When filling out an application form, fill up every details asked for. An incomplete form is rejected.

 Do take special care while filling up ECS refund as missing out on it will result in a non-refund in your bank account.


The Bottom line

Picking the best IPOs is not so hard if you know what to look for. You can use these IPO investment tips as a ready reference point every time an IPO comes along.


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