Things to know before buying an IPO

Introduction

Investing in an IPO is often considered the quickest way to make money in the equity market. Companies launch IPO (Initial Public Offering) to raise funds from the public. They use the money to fuel business growth or consolidate debt. Investors willing to profit from an IPO needs to keep specific factors in mind to ensure their investment fulfils their financial goals.

Here is a laydown of the top factors you need to consider to ensure your IPO defies gravity and fetches you excellent returns.

Analyse the DRHP

DRHP or Draft Red Herring Prospectus is a mandatory process undertaken by the company willing to go public. Usually, a merchant banker helps the company understand the nitty-gritty of a public issue. The Securities and Exchange Board of India (SEBI) evaluates and publishes the DRHP before giving the IPO the go-ahead. 

The DRHP contains vital information about a company’s business operations and financial status. You can find all details about the promoters and the reasons for going public. For example, if the IPO is used to give Venture Capital (VC) funds an exit route, the company might not get the proceeds from the IPO. 

Besides finding information about the promoters, the DRHP also mentions the business risks, the risks of investing in the IPO, and other details. However, it usually does not contain any information about the issue size or price.

If you do not know how to scan DRHP like a professional, 5paisa simplifies it for you. All you need to do is click on the ‘Upcoming IPO’ tab and read a detailed research report of the company going public.

Evaluate the purpose of the IPO

Learning about the purpose of an IPO is essential to gauge its potential. A company may go public for several reasons, including funding its day-to-day operations, launching new stores or manufacturing facilities, buying equipment, or simply consolidating existing debt.

If a company invests the proceeds from an IPO on business growth, investors will likely be willing to bet big on the firm. In contrast, if the amount goes only for debt consolidation, you must carefully evaluate the other financial parameters before investing your hard-earned money.

Invest in the business; not the company

A company is as good as its business. Hence, before investing in an IPO, you must verify whether the company has a robust vision for carrying its business operations or not. If the company’s vision and mission are dubious, it may not offer the growth you expect. 

A wise way of gauging the business value is by looking at its peers and the industry dynamics. For instance, the Pharma sector in general and API, in particular, rose into prominence after the COVID-19 pandemic. And, when the industry and peers are at their peak, the new IPO may also perform similarly.

Scan the promoter’s profile

The promoter is the most important functionary in a company. The promoter, along with the management, influences the company’s business prospects.

While checking the promoter’s profile, look at their track record. Also, inquire whether the company has been subject to any legal cases or not. If the promoter’s profile and image are clean, you can have additional reasons to invest in the IPO. 

Gauge the company’s potential

If a company has an excellent reputation in the market, its chances of delivering higher returns are more. However, there is no holy grail system of understanding a company’s potential before listing. 

Some investors look at the Grey Market Premium (GMP) of an IPO to calculate the probability of its listing at a premium or discount. GMP is an unofficial figure that tries to estimate the listing value of an IPO. 

The company’s key strengths

An investor needs to find the company’s key strengths and competitive advantages before investing in an IPO. The key strengths may be financial, human resource-driven, product or service-based, or anything else. For example, if a company manufactures something that no other company produces, it will have a competitive edge in the market.

Besides the DRHP, you may look at press releases, research reports, brokerage recommendations, and newspaper info to find more about the IPO. While an asset is classified as a strength, it might also be a weakness if it is a non-performing asset.  

Valuation and comparative valuation

While valuation refers to the IPO price vis-a-vis the company’s financial status, comparative valuation is the company’s valuation against other similar companies in the sector. If a company’s valuation and comparative valuation are positive, you must invest in the company. In contrast, if the company is loss-making and yet exorbitantly priced, it should ring alarm bells in your brain.

5paisa simplifies IPO investments

Now that you know the top factors to consider before investing, head to 5paisa’s ‘Upcoming IPO’ segment to check the top IPOs that are open for subscription. You may also read research reports and expert recommendations for free and make a wise decision.