Tips for Investing in IPO

Introduction

In the wake of a raging pandemic, a second-consecutive year of lockdowns and restrictions, Indian markets had their most illustrious year yet, with a record 63 companies joining the bourses and raising ₹1.2 lakh crores. This includes blockbuster names, the likes of PayTM, Zomato, Nykaa, and more.

With super-sized returns in the form of listing gains, retail investors are going all-in to make the most of this opportunity. Given the low-interest rate scenario and disappearing fixed income returns, more and more savings are making their way towards speculative investments such as initial public offerings, often recklessly.

While IPOs can generate significant returns for retail investors, who are often restricted from investing in private companies and securities. However, with the increasingly crowded equity markets, coupled with sky-high valuations, IPO investing isn't as straightforward as it once was, which is especially true with the recent PayTM fiasco.

Of the 63 companies that went public in 2021, 14 listings provided multi-bagger gains for investors with over 300% returns, 21 others saw their valuations erode by over 52% since listing. IPO investing is an entirely different ball-game off-late, and investors need to develop a keen understanding of its workings. You can get started with these fundamental tips before digging further.

Research Fundamentals

If there is anything we can learn from the PayTM fiasco, brand names and clout do not necessarily translate into bumper listings or gains. No matter what the market conditions reflect or how popular a company is, it ultimately comes down to the fundamentals of its balance sheet and overall business model.

A sophisticated investor would pay keen attention to indicators in the balance sheet, ranging from cash and debt levels, along with key financial ratios indicating liquidity, leverage, margins, and more, for understanding what the future holds.

There are numerous analysts and investors who review IPOs based on their merits, sharing their views and forecasting the overall prospects of the company, which can be of great use for new investors and retail traders looking for listing gains.

The story, founders & promoters

Every company anticipating a listing on the bourses has a story to tell, starting from its years as a startup, its goals and visions, adversities, and of course, its founders, promoters, and early investors. Getting a good understanding of the company's history and that of its founders, promoters, and investors, helps you gauge the trustworthiness and long-term goals of a company. 

You should stay away from IPOs that have sketchy promoters, as they are likely to have more than a few hidden bodies that might compromise on the long-term public prospects of a company.

Choose IPOs with strong underwriters

Underwriters and brokerages lead the IPO process, and quality underwriters often associate themselves with quality companies. When taking a company public, underwriters extensively evaluate the company, its business model, promoters, and finances before putting their names on the listing.

While smaller firms are likely to work with all deals that come their way, reputed underwriters can afford to be selective while maintaining and upholding the public trust. Firms such as Bank of America and Citigroup command a lot of trusts, which can translate into strong demand from the public and listing gains eventually for investors.

Read the prospectus

Most retail traders often give the extensive IPO literature and paperwork a miss and tend to go with the flow. However, in order to protect your hard-earned money from substandard companies and rogue promoters, it is essential to dig through the prospectus.

The prospectus lists everything materially relevant to the IPO, ranging from how and where the company plans to invest the proceeds from the offering and key insights into the risks and opportunities surrounding the company and its market.

Ideally, a company that plans to invest in research, marketing, and expansion is more likely to gain investor trust than a company whose promoter plans to use the IPO to cash out. An experienced investor can identify many subtle clues by going through the prospectus, helping make informed decisions.

Final Verdict

Investing in IPOs is, without a doubt, a great way to build wealth. It is, however, far from a lotto ticket that most retail investors consider it to be. A nuanced approach can result in consistent gains while minimizing losses. There are numerous websites and newsletters curating the best IPOs to buy or which IPO is best to buy today in India. 

Here again, speculative investing may not yield results for long. Investing in D-Mart at the time of its IPO would have provided investors with over 20-times returns within just three years, but similar short-term missteps tend to cost investors dearly, making them lose their hard-earned savings in the process.