Whether you’re new to the world of stock market or a seasoned investor, you must have heard of companies issuing IPOs and investors flocking to invest their money into them. If you’ve also had the urge to do so, then this article is for you. Investing in an upcoming IPO without proper due diligence on your part is something that you should never do. But then, how do you decide if an IPO is worth investing in? Here’s a guide that can help you determine just that. But before we dive in, let’s first try to understand what an IPO is.  

What is an IPO?

An Initial Public Offering (IPO) is one of the most efficient ways for a company to raise funds. A company that’s desirous of raising funds can choose to sell its equity shares to the public via an IPO. The funds that the company raises in such a manner can be used by it for various purposes such as for expansion of its business, for acquisition of other businesses, and for paying off its debts. Raising funds through an IPO is very cost effective for the company since it doesn’t have to pay interest on the funds or make any repayment to its investors.

How is an IPO beneficial to the investors? 

An IPO is not only advantageous for the company, but can also be very beneficial to its investors as well. By purchasing the shares of a company through its IPO, investors become its shareholders and can take part in the wealth creation process early on. This is one of the many reasons why investors usually tend to flock towards an IPO. 

Some investors also participate in an upcoming IPO in the hopes of taking advantage of listing gains. Listing gains is when the share finally hits the stock exchanges for the first time and appreciates in value beyond the price at which it was allotted to the investor. Many investors tend to exit the company by selling their holdings for a profit during the first few days itself after experiencing listing gains. 

How to decide if an IPO is worth investing in?

Now, contrary to popular opinion, not all IPOs experience a stellar debut on the stock exchanges. There have been numerous examples where IPOs haven’t lived up to the expectations of investors and the market. 

This is precisely why it is important to analyse an IPO to ensure that it is worth investing in. And to do that, there are a few things that you would have to take into consideration. Here’s an indepth look at a few of them. 

1. See if you understand the business 

This is the first and one of the most important things that you would need to take into account when deciding whether an IPO is worth investing in or not. Many stock market experts advise investors to only consider investing in a company if they understand its business. This is very good advice since you would be in a position to gauge the company’s financial performance and future prospects only if you understand the business, industry, and the market it operates in. 

2. Check the company’s position in the industry

The next important factor that you need to account for is the company’s position in the industry. If the company issuing the IPO has a good hold over the industry in terms of market share or is the only player in the entire industry, you may choose to invest in the IPO since the chances of share price appreciation is likely to be high in the near future. However, if a company is operating in an already overcrowded industry or has little market share, then it may be prudent to give its IPO a miss. 

3. Check business’ financial performance

The financials of a company gives you a host of key information about the company. You  can find the company’s financial performance for the last few years in the Red Herring Prospectus. When going through the company’s financials, make sure to check its revenue and profit. Also keep an eye on its expenses and liabilities. 

For instance, if a company’s revenues and profits have been rising steadily over the past few years, you may choose to invest in the upcoming IPO. However, if a company has been consistently making losses year after year, it might be a good idea to hold out from investing in it.  

4. Check the background of the promoters and senior management 

The promoters and the senior management are the heart and soul of the company. And so, to get a good idea of the company and its operations, you would have to take a look at the background of the promoters and the management. 

To start off with, you can first take note of the experience of the promoters and the number of years they have been involved with the company. If there has been a frequent change in the senior management of the company, then you might want to hold out on investing in the IPO. 

5. Take a look at how the company plans to utilise the funds from the IPO

The Red Herring Prospectus gives you several important information regarding the Initial Public Offering of the company. One among the many pieces of information is how the company plans to utilise the proceeds. 

If the company plans to use the funds raised through the IPO for expansion of its business, for purchase of equipment, or for acquiring other businesses, it is a good sign and you may consider investing in it. 

However, if the company hasn’t outrightly disclosed how it plans to use the funds or if it is only planning to use it to clear off some of its debts, then you might have to give it a second thought.  

Conclusion

Analysing the five things mentioned above should give you a good idea of whether an IPO is worth investing in or not. That said, remember that the above list is merely illustrative and not exhaustive. 

There are several other things that you can and should take into account while evaluating an IPO as well such as the company’s future growth potential, key strengths, risks, and how it fares compared to its peers, among others. 

If you’re interested in investing in any upcoming IPO, then make sure to first open a demat account. Contact Motilal Oswal right now to open one for free. 

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