Invest in IPO – 6 Factors to check before you invest in IPO

When two persons decide on a business venture they start with their own funds. When the business grows it requires more funds from outside in the form of equity or borrowing funds from other people. When people invest in IPO they become the shareholder of the companies and help the companies to grow.

So in order to raise the funds from the public, the company needs to get listed or become a public limited company. Thus, the process by which a private company becomes a public limited company by the sale of its stocks to the general public for investment is known as Initial Public Offering or IPO.

So, investors when wants to put money in the company in exchange for a stake in the company will need to analyze the IPO. The analysis is done on the basis of certain factors which need to be considered before you invest in IPO.

Factors that need to be considered before you invest in IPO:

An investor needs to know about the background of the company in which they want to invest as they should know whether the business is running in profit or not.

Investor needs to find out the company’s position in the industry it operates in.

•  The financial performance of the company needs to be checked in order to ascertain whether the revenues and profits of the company are growing or have fallen down over the past three years. If the revenues and profits are increasing, it would be a good investment. However, if these are declining, then Investment should not be made.
• Future prospect of the company needs to be ascertained as the company that comes for initial public offering should have a good business model to sustain in the future.
• An investor should know the reason why the company is raising funds through IPO. If the company wants to raise funds for expansion of the business or for the retirement of debt, then it’s a good opportunity to invest in IPO as this would enhance the revenues and profitability of the company in the future. But if money is raised for the purpose of meeting working capital requirements then it is not wise to opt for this IPO as it will have an impact on the profitability of the company.
• Shares should be valued in order to have an idea that the price of the shares is fairly valued or overvalued. Ratios like price-to-earnings and price-to-book-value should be taken into account and should be compared with its peers for the right valuation, it means that the shares are available at a fair price and one can consider to invest in IPO. However, if it is overpriced in comparison to the shares of peer companies, then the investment should not be made.
• One should also check out if any pending legal issues plague the company or not as they would inflict loss of capital due to legal battles. If they don’t have any then it would be fine to invest into the company.
• Rating by the credit rating agency like CRISIL, CARE, India Ratings, etc. to the upcoming IPO gives the investment grade for the IPO. Like if an IPO gets grade of 4 to 5 then it’s good for investment purpose as company is financial stable.

But now the question arises from where will the investor get to know about the above-mentioned factors. For this, they should refer to the DRHP (Draft Red Herring Prospectus), that the company files with SEBI. It is the document that provides detailed information about the company’s business operations and financials.

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However, if the company meets all the above parameters, we can expect good returns from the IPO. But if the above parameters are not met then if you invest in IPO it will not provide any benefit to the investor.

How to analyze an IPO?

Before taking the full decision on whether one should invest in IPO or not, investor should analyze the IPO.

An investor should analyze the size of fresh issues and of an offer for sale. The capital which is used by the company for its business operation is known as fresh issue and when the promoter or private investor sells a part of their stake in the company is known as offer for sale.

Since IPO is the combination of fresh issue and offer for sale investor should have the knowledge of proportion of offer for sale and fresh issue.

If proportion of Offer for Sale (OFS) is greater than Fresh Issue, the promoters are selling their stake which is not a good signal for the company.

If the proportion of Offer for Sale (OFS) is lower than the fresh issue, it indicates that the company has a good growth prospect and promoters even have good faith in the business model.

Let us understand this with an example:

We will take the example of Equitas Small Finance Bank that has debuted the shares at a 6% discount to the issue price on 2nd November 2020.

Equitas Small Finance Bank is one of the leading players in India, that caters to the mass market on “financially unserved and underserved segments”.This company offers a diversified portfolio of products comprising small business loans, microfinance, vehicle finance, MSE finance, corporates, and others.

Equitas Small Finance Bank raised nearly Rs 518 crore via a public issue that comprised of a fresh issue and offers for sale out of which Rs 280 crore was raised through the fresh issue.

Taking into consideration the background of the company and its proportion shares we come to the conclusion that you can invest in IPO as it is a good deal for the investment.

Frequently Asked Questions

Key Takeaways

• Before the private company gets listed on the stock exchange the first public offering of the shares is known as an Initial Public Offering.
• IPO is made through an offer for sale and fresh issue.
• Before investors invest in IPO, they should know about the company’s background, its financial performance, and future prospect.
• Investors should know about the reason behind the IPO by the company as if it’s for expansion of the company then it’s a good investment prospect.

Happy Learning!