Investing in companies' Initial Public Offerings (IPOs) has become a trend. Whether an experienced or a rookie investor, you can invest in promising IPOs and get handsome returns within a few days. Some recently launched IPOs, including Cyient DLM, Utkarsh Small Finance Bank, Mankind Pharma, and ideaForge Technologies, have given excellent gains to investors.
However, not all IPOs have the potential to deliver equivalent returns. While some list at a high premium on the secondary markets, some fail miserably post-listing, resulting in significant losses. So, how to decide whether an IPO is good or bad?
Start Investing with Free Expert Advice!
Well, no one can accurately predict the returns an IPO can generate, but here are a few tips that can help you make informed investment decisions:
When a company decides to launch its IPO, it files a Draft Red Herring Prospectus (DRHP) with the Securities and Exchange Board of India (SEBI). In this document, the issuing company mentions almost all necessary details regarding an IPO, such as the issue size, number of equity shares that will be available, prospective price band, face value of shares, etc.
Thus, by reading the DRHP thoroughly, you will know the essential details of an IPO. You can also gain knowledge about the issuing company’s financials for the last three years, strengths, risks, and other information that can help you evaluate whether you should invest in an IPO or not.
You should always check for the reasons behind an IPO before investing in it. By doing so, you will know how an issuing company plans to use the proceeds from an IPO.
A company can float an IPO for several reasons, such as expanding existing business, acquisitions or mergers, repayment of debts, and raising working capital for daily operations. If a company plans to repay the debts through an IPO and fund further expansion, it reflects that the money will be used properly, which is a positive sign for investors.
It’s crucial to be aware of a company's business model before investing in its IPO. Also, make sure you are clear about the products or services it offers to its clients or customers. Once you understand these things, try to identify market opportunities. Doing so will help you analyse whether the company will make profits in the future and how it plans to do so.
It has historically been observed that companies with clear and robust business plans can only survive in the long term. So, if a company’s business plans seem unclear or complex, you can avoid its IPO.
The issuing company itself does the valuation of an IPO after consultation with an investment banker or underwriter. They assess the demand an IPO can generate based on the company’s financials, current assets, liabilities, past performance, and the ability to generate profits in the future.
If an IPO seems fairly valued, it’s a good idea to invest in it. However, if an IPO seems overvalued, it’s better to avoid subscribing to it. Such IPOs tend to lose value after listing.
Make it a golden rule not to invest in an IPO based on the hype or euphoria during the pre-listing phase. Remember, big names do not guarantee high profits. You must always look for a company’s fundamentals and other details mentioned in the DRHP.
Moreover, you need to be extra careful if you invest in an IPO for the long term. Sometimes, overhyped IPOs can provide significant gains on the listing day, but their values evaporate in a few months or years.
Investing in IPOs can be an excellent way to make quick money. However, it’s essential to select an IPO based on the issuing company’s fundamentals instead of the market hype. Reading the DRHP fine print thoroughly and making investment decisions only after a lengthy analysis is better.
With Motilal Oswal, you can open a Demat account for free and enjoy a gamut of exciting features that can make your IPO investments seamless.