By Harjit Singh
Over the past few months, a large number of companies have submitted floating initial public offering (IPO) proposals. On top of that, a number of IPOs are expected to hit the market soon. As companies line up to raise funds in the market against a backdrop of high valuations, there are many factors that investors need to consider before investing their money in an IPO.
Take into account investment objectives
Before investing in an IPO, there are a few questions you should ask yourself about what type of strategy you should consider. The reason is that an investor cannot always decide what kind of investment decision is right for him if he is not clear about his investment objectives. Additionally, a number of your choices can only be judged based on your current investment portfolio.
For example, if investors are heavily invested in large-cap stocks, investing in an IPO of a large company can make their portfolios even more uneven. On the contrary, investing in an IPO powered by a small to mid-cap company can help balance the portfolio.
Look at your investment horizon. What is your goal to enter an IPO market? Would you like to snatch a quick profit? Or do you want to keep shares longer? This will ultimately decide your IPO strategy. A short-term investment strategy relies heavily on market sentiment while a long-term disposition will require you to consider the fundamentals of the business.
Since IPO investing is a high risk, high return game, you need to question the rationale for the investment. Here are some important questions an investor should think about before investing.
n Will you be ready to own the stock if prices drop 40-50%? Answering this query will shed light on your real investment goals.
n What percentage of your portfolio would be allocated to IPO investing and what is your risk tolerance? Investing in an IPO is totally different from investing in listed companies and this question will demonstrate your appetite for risk.
n Are you planning to invest in an IPO to “turn it around” (short-term strategy) or do you intend to stay for the long term? This question is targeted to make your trip direct. The answer to the question may change the type of IPO you choose and your consideration points may change as well.
Golden rules for investing in IPOs
Making money in an IPO is not as easy as it sounds. While you’ve decided on your investment goals and the right strategy to achieve them, you still need to select the right type of IPO. There are several rules that can help you determine the right problem. The main ones among them are: –
DRHP: The Securities and Exchange Board of India (Sebi) has made it compulsory for companies going public to submit a “draft red herring prospectus” (DRHP) to it. This document constitutes a rich source of information which can modify the decision of the investors, if they consult it seriously. For example, the prospectus highlights the current model of share distribution. A higher percentage of shares held by banks and institutional investors is a positive sign, indicating their confidence in the performance of the company. You can also get to know the management team, the company’s future plans and their qualifications.
Profile of the promoters: One of the important rules is to know the entity which is promoting the IPO. Well-established names, organizations add credibility and add a premium to the floating price.
Rating: The rating of an IPO also plays a vital role in the IPO market. The higher the rating, the better the chances of a successful IPO. However, this is inconclusive as companies with outstanding ratings have had to withdraw their IPOs.
Invest in the business you understand
Never invest in a stock. Instead, invest in a business. And invest in a business that you understand well, otherwise never invest. Renowned investor Warren Buffett always says, “Invest in your area of expertise. The reason behind this philosophy is that a thorough understanding of a business can help you make sound decisions.
Last but not the least, listen to everything, but do your own SWOT analysis instead of just hearsay. Choosing the best IPO isn’t that hard if you know what to look for. Plan your finances wisely and don’t put all your eggs in one basket. Diversify it.
The writer is Associate Professor, Amity School of Business, Amity University