How to spot problematic IPO prospects | Motilal Oswal

How to filter out bad IPO prospects

IPO or Initial Public Offering refers to the first instance when a privately-owned company decides to list its shares on a public stock exchange forum. With the market buzzing with new and upcoming IPO prospects, sifting out the more profitable ones from the sheer bulk of offerings available in the market can be an arduous task for investors. Knowledge about IPO red flags can guide them on their quest for the most profitable IPO options.

IPO Red Flags to Avoid

Reviewing financial statements and annual profit ratios can help investors evaluate the prospects of a company’s IPO. Since consistent profit and growth records of a company suggest an optimistic future, investing in such IPOs is a good option to consider. However, inconsistent numbers may be interpreted as signs of stagnation. Picking IPOs of such a company may not be a practical investment choice from a profitability standpoint.

Brokers Pitching an IPO Too Hard

A broker strongly recommending an IPO is one of the most significant signs of troubled waters. This situation only arises if the underwriter’s attempt to sell the stock to institutions and money managers has failed. Since this can only happen if the prospects of the IPO are poor, avoiding the same may be a wise choice for investors.

Scarce Availability of Information about the Company

While it is generally difficult to find comprehensive information about privately-owned ventures going public for the first time, performing due diligence may be a judicious way to avoid unprofitable IPO investments. Exceptionally scarce information about a company about to go public may be a significant red flag since such information helps investors make informed decisions. If there’s a lack of credible information about the company – apart from its underwriter-generated prospectus- the effective value of the IPO investment can be called into question.  

Funds for Loan Repayment Purposes

How the company is planning to use the money raised through its IPO can help investors filter out bad IPO prospects. A company that plans on settling debts through its IPO-generated funds may not be a prudent choice for investors since such a fund utilisation plan suggests that the company needs to issue stock to repay its loans.

Insiders Selling the Stock after the Lock-Up Period Expires

Every IPO has a legally binding lock-up period ranging from 3 to 24 months. During this period, company insiders are legally barred from selling their shares. Insiders holding onto their shares after the expiry of this period can be suggestive of the profitability of the IPO. However, company insiders selling their stocks immediately after this stipulated lock-up period is concluded can be symptomatic of brewing overvaluation trouble. Thus, keeping an eye out for this major IPO red flag may be prudent for investors.

Conclusion

While companies like Paytm, Policybazaar, Zomato and others have already made their share market debuts in 2021, the long list of upcoming IPOs is a testament to the ongoing IPO frenzy in the Indian stock market. Avoiding the aforementioned red flags can help investors cultivate a cautious approach and pick the right IPOs to churn out profitable returns on their investments.

If you wish to start investing in the latest IPOs, you can open a Demat account online. Since the process of opening one is exceptionally simple, you’ll be ready to pick and choose IPOs for your portfolio in no time!

Related articles: 5 Tips for Investing In IPOs | What's the big deal about IPOs | Clearing the confusion from IPOs | IPO in India- The future looks bright | Upcoming IPO | LIC IPO

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