Don’t jump to IPO bandwagon, factors to look at before investing in an IPO

In 2021, several initial public offering (IPO) and their stellar debut are making headlines. Right from food delivery app to pharma to tech startups to chemical manufacturing firms have gone public. The bullish sentiment in the Indian equity market and the robust liquidity helped to keep the IPO market buoyant in the recent times.  Many more IPOs which is the process through private companies raise funds from the public will be launched in the coming months. Amid the higher valuation of the domestic equities, IPO can be good alternative investment opportunity for the investors to earn better returns. However, don’t get carried away by the IPO hype.  Be a rational investor, evaluate the below mentioned factors before investing in an IPO. Apart from these factors, investing in IPO should always in sync with investor’s personal financial goals and risk appetite.  Avoid taking huge bets on an IPO with the help of the borrowed funds in anticipation of bigger gains as equity market is highly unpredictable in nature.

Understand the business of the company and purpose of raising money 

First and foremost get a detailed view of the company business. This will include evaluating which sector the company belongs to, experience, past record of the company’s promoter and board of directors, corporate governance, why is the company launching an IPO – is it planning to pay off the debt or planning to expand. Note IPOs are typically exit medium for the venture capitalist and private equity firms who have invested a huge sum of money in the initial stages in the private company before they plan to go public. This in turn will give you an idea about the future growth potential of the company.

Peer group analysis is vital

Investors should study other listed companies in the same sector or businesses. Check the company’s valuation vis-à-vis its peers. In case if the IPO pricing expensive or valuation is higher than the upside potential might be limited. Also note that unlike the listed companies which have detailed disclosures and past records, in case of IPO the investor may have only limited information which are typically published in the Draft Red Herring Prospectus (DRHP). DRHP is the document that provides detailed information about the company’s business operations and its financials.

Evaluate the risk factors

When it comes to IPO, investors often look at the listing gains. However, there are times when the companies may not get listed at a premium but at a discount. So, investors with higher risk bearing capacity should consider investing in IPO. Further, it is important to check other risk factors this may be outstanding litigation against the company, promoter or liabilities or any other external factors influencing the price. Management's view on internal and external risks to the company and any forward-looking statement are also important to look into.

Subscription of the new issue

While investing in IPO it is crucial to look at the subscription by qualified institutional investors for the IPO, as it can give an idea of the quality and pricing of the issue. Rising retail participation in the Indian equity market often resulted in the substantial over-subscription of many IPOs in the recent times.  While a strong subscription can be a good indicator but not necessary it will result in strong listing gains. At times the shares might get a lukewarm response on the bourses due to other market related factors. 

Summing up

IPO is the key element of the market as listing of large number of good companies offer a greater number of good quality stocks to investors and also helps companies to grow by raising funds for their future businesses. IPOs are good booster for the Indian startup culture as it helps in flourishing of more innovative ideas and lift the entrepreneurial spirit in the country. Investors can consider investing only after evaluation of the aforementioned factors and only if they have higher risk appetite as equity markets are highly volatile in nature. Remember, if the listing of the company was disappointing don’t get disheartened at times the companies with good potential can perform better in the long run.