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6 Things to Keep in Mind While Investing in IPOs

  • Rudri Rawell
  • Dec 13 2021
  • 6 minutes
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This year almost felt like it was raining IPOs in India. The IPO or Initial public offering run saw many start-ups going public to open a range of opportunities for investors in general. Zomato’s IPO is known to have been oversubscribed 38 times before closing on July 16. Paras Defence and Space Technologies Limited’s IPO was oversubscribed 304 times to set a record as the most subscribed IPO in the history of Indian stock markets.

Once these IPOs are launched, the market waits to see the initial share performance on the markets. Most investors rush in making IPO applications due to the common belief that the stock prices may shoot up once the company is listed. This is considered as a great opportunity to book profits quickly. However, there are some important factors to be kept in mind while investing in IPOs, especially for new investors. Here are some of the key points.

1. Know the investment purpose

Investing in an IPO with the sole purpose of fetching listing gains could go against one’s expectations. Investors, especially those who are just starting off with equities, should know personal risk profile and weigh their decisions keeping in mind investment objectives. To identify the right investment, whether IPO or some other avenue, it is best to consider the fundamentals and possibility of long-term gains rather than having a short-term listing gains view.

2. Study company profile

Before investing in an IPO, an investor must ensure to check the company profile to study its capabilities through performance over the years. Looking at the company’s financial history can help in understanding its overall growth potential. With this information, an investor can try to gauge the precise reason why the company may be going public through the IPO and in which areas it intends to spend the funds from the IPO. 

3. Evaluate the company’s value

Studying a company’s valuation is another crucial factor that an investor must consider while investing in its IPO. The best way to do this is to compare the company’s price-to-earnings ratio and return on equity against its peers. 

  • Price-to-earnings ratio = Share price of the stock / Earnings per share.
  • Return on equity = Net income / shareholder’s equity

Analysing a company’s financial data can help in gauging its financial health and assessing its growth capacity. For example, an investor can look at the company’s debt-equity ratio to assess the degree of leverage being used. 

What does a debt-equity ratio tell investors?

A high debt-equity ratio indicates a higher risk to the company’s lenders and investors since it means the company is using high amounts of borrowed funds to attain growth. 

A company’s earnings per share (EPS), return on capital employed, cash flow, etc. can help investors in appropriate decision making. It is best for investors to avoid investing in an IPO if the financials do not compare well with peers and if its valuation looks weak.

4. Beware of oversubscription

During an IPO, a company may offer a limited number of shares. The allocation of shares to various investor categories is mostly pre-decided. At times, the total number of applications towards an IPO may be much more than the number of shares being offered. However, share allotment among all the applicants is done in a proportionate manner. It is, therefore, possible that an investor gets fewer shares than actually applied for. So, it’s wise to be cautious about over-subscription since it can impact one’s investment plans. 

5. Read the fine-print through company prospectus

A company’s prospectus contains details about its business, capital structure, financial statements, management views, etc. While it gives an overall picture of the IPO, investors can also get a view of the fine-print from the prospectus. Going through these details can help in being better prepared for an investment decision.

6. Following the hype v/s independent investment decision

It is important to be objective when it comes to an investment decision. If, for example, the current stock market situation is on a downward spiral, it raises the speculation on the IPO performing poorly in the short run. However, it can have a brighter future if the company’s fundamentals are strong. Investors must therefore avoid getting carried away by market hype while deciding on an IPO investment.

Conclusion

Ensure to invest in IPOs only if it is in sync with your risk appetite and financial goals. Many seasoned investors invest in an IPO on the second or third day post opening to have sufficient time to assess public response. If an issue is oversubscribed, there are higher chances of listing gains. In the end, an informed investment decision can go a long way in fetching positive returns as against following a plain market hype when it comes to IPOs.

FAQs

How can I increase my chances of IPO allotment in India?

Some of the ways to improve chances of IPO allotment in India are to avoid last-minute rush, apply through multiple Demat accounts, and buy parent company shares.

Can you sell IPO shares immediately?

Yes, you can sell IPO shares immediately / on the listing day to make listing gains, if applicable but the gains made will be subject to Short Term Capital Gains tax

What is a Red Herring Prospectus?

The draft Red Herring Prospectus is required to be filed by a company with SEBI when it plans to raise capital by selling shares to investors through an IPO. This document gives details of how the company plans to use the funds to be raised and if there are any risks for investors. Investors must go through this document before investing in an IPO.

How are retail investors allotted shares in an IPO?

In case an IPO is oversubscription, the company first adds up all the retail bids to divide this amount with the minimum ‘lot’ value to know the number of retail investors to be allotted shares. For example, if a company has offered Rs. 10 lakh worth of shares and the minimum lot is Rs. 1,000, then 1,000 retail investors will be allotted shares. If there are more retail investors who have bid, the eligible retail investors are selected using a computerised draw.

What is a qualified institutional buyer?

As per SEBI, qualified institutional buyers are defined as investors who possess the required expertise, combined with the financial background, to make strategic investments in the capital markets. Some examples of QIBs are mutual funds, scheduled commercial banks, venture capital funds, pension funds, etc.

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