An initial public offering (IPO) or stock launch is a public offering in which shares of a company are sold to institutional investors and usually also retail (individual) investors. An IPO is typically underwritten by one or more investment banks, who also arrange for the shares to be listed on one or more stock exchanges. Through this process, colloquially known as floating, or going public, a privately held company is transformed into a public company.
The domestic primary market is set to have an even busier second half of the year, with many IPOs lining up to float their initial public offerings. This is an opportunity for investors to add stocks to their portfolios at the offer price. Indian companies have raised nearly $3 billion via IPOs so far in 2021, the best start of a year since 2018. Market liquidity is aided by both foreign and domestic investors. The gradually recovering economy has boosted investor sentiment, making it an opportune time for companies to list on stock exchanges.
The retail investors have shown keen interest to participate in the recent IPOs and if you too want to invest in an IPO, here are five things to keep in mind before you do so:
1. Do your due diligence before investing in an IPO:
Stock exchange regulations require all listed companies to publicly disclose crucial financial and corporate governance-related information that can impact their stock prices. These rules, however, do not apply to companies that are not publicly traded. This is why investors/traders need to carefully conduct their due diligence. Look for as much information as possible regarding the company's finances, track record, promoters, and so on. All this crucial information is available in the Red Herring Prospectus (RHP) which comes as a useful handbook while investing in an IPO. One can refer to the RHP on the official website of SEBI.
2. Utilisation of money raised from IPO:
It's crucial to inspect how the proceeds from the IPO will be used. If the company solely wants to pay off the debt, it probably is not an attractive investment. However, if the company aims to use the money for both further expansion and paying off debt, it has a promising future that is worth considering.
3. Peer-to-peer comparison:
Comparing an IPO with its peer group is another excellent method of analysing it. If the upcoming IPO has strong financials and a low valuation vis-à-vis its peers, it is worth investing in.
4. Learn about risk factors:
Sometimes even after reading financials and understanding how a certain company operates, it can be difficult to understand the other risks that the company carries. Reading the company's DRHP (Draft Red Herring Prospectus) can help you understand such risks. In the DRHP, a company includes all risk variables that can affect it in the short- and long-term. Litigation, contingent liabilities, and potential challenges to its normal business operations are all included. So, be informed.
5. Future prospects of the sector/industry:
Understand the prospects of the sector, before you invest in the IPO. For example, currently, the pharma sector is one of the best-performing sectors amid the Covid-19 pandemic. And going forward, it is likely to continue to do well as the government is constantly finding ways to improve the policies and support the sector. Similarly, other growing sectors like education technology and information technology, which have a promising future, must be considered while investing.
IPOs are a great way to find value stocks, but these come with their own set of risks. Make a decision based on how much risk you're willing to take and how strong the company's fundamentals are in relation to its valuation. If you decide to invest in an IPO, conduct objective research and read the prospectus thoroughly.