The lure of owning a new piece of business is what has always driven retail investors to the Initial Public Offerings (IPOs). The queue of companies planning to raise money through IPO is getting longer with each passing day. Moreover, IPO frenzy has taken a stronghold among many retail and institutional investors as prominent companies like Policybazaar, Paytm, Nykaa, Oyo are gearing up to launch their own IPOs. But history has been a witness that the euphoria in the IPO market has not always been kind to the investors. They often end up with their hands cinched by subscribing to the wrong IPO. Look no further and take the example of the recent state of IPOs that hit the market in the first half of 2021. Out of 20 IPOs, 4 are trading below the trading prices while 7 are below their listing price. This tells that, out of the total IPOs issued more than half of them didn’t end up giving handsome gains (or gave losses, for that matter)
Promoters and Merchant Bankers often tend to price IPOs as high as possible leaving almost nothing for the retail investors. But, on the other hand, they say that if one picks the right issue to bet on, they can be rewarded with not only handsome listing gains but also end up owning a company that only compounds their investment. So, is it that difficult to choose a good-performing IPO? Nah. It depends on the parameters through which you assess the company issuing it. Well, I have got you covered in that case. Let’s discuss things to look at before hitting subscribe on an IPO!
1. Business Model:
The first thing to do after getting the news that a particular company is issuing an IPO is to know its business model. Business model refers to the company’s plan for making a profit. It represents the products or services the company plans to sell, the expenses to be incurred, and its target market. Along the way, understand the chances of the company having sustainable growth and business visibility in the coming years.
2. Industry Dynamics:
If the company is new and the investors don’t have much secondary data available to support their research, studying the industry dynamics comes in handy. It includes the pricing power, capital intensity, barriers, and future opportunities that the company may have in store. It is the study through which we can gauge how an industry will change or evolve over time. To study the industry dynamics, Porter's 5 forces and SWOT analysis can be done.
3. Management track record:
For investors, getting their hands on the Management track record can be tricky because the company has not been listed and has never been in the public domain. But the investors can look for information like if the company has a good track record in the market, uses capital efficiently, read about risk factors to be aware of contingent liabilities and litigation. For in-depth analysis, check the background of promoters and management as well as lead book managers to see if the remuneration is in line and are there any threats related to future dilution.
4. Current market sentiments:
Market sentiment refers to the investor’s outlook or attitude towards a stock. Underpricing is significantly higher for overvalued IPOs than for undervalued IPOs, and is positively correlated to market sentiments. Looking at the market sentiments can give a brief idea about the outlook of the company and its growth prospects.
5. Reasons for issuing:
An IPO may be the first time the general public can buy shares in a company, but it’s important to understand that one of the purposes of an IPO is to raise additional capital. There are other reasons for a company to pursue an IPO like an offer for the early investor to cash out their investments, just to get listed and get a huge amount of publicity, to expand the business, fund research, or pay the debt. The reasons give you insights as to what the company is doing forward.
To recapitulate, proper due diligence and selecting the right bid can result in windfall profits provided that one doesn’t just subscribe because of FOMO or get-rich-quick mentality.
