10 things you must do before buying an IPO, but nobody tells you about them

With a large number of IPOs lined up for the coming months, Calendar 2021 is believed to be a record year for investing in IPOs in India. The IPO stocks that were listed in 2020 are now trading above their issue prices, with some having gained as much as 400% since listing. All these make IPO investing an exciting option for investors looking to enter the market. There are a few big names like Paytm, Bajaj Energy, Nykaa and LIC slated to hit the market before the end of this financial year.

However, one needs to understand that just like the stock market, IPOs come with a fair share of risk, and due diligence is required before investing in them. Should you decide to invest in an IPO, here are some points to keep in mind:

1.
Always Read the Red hearing Prospectus: The Draft Red Herring Prospectus, or DRHP, is filed by a company to Sebi when it intends to raise money from the public by selling shares of the company to investors. DRHP also elaborates how the company intends to use the money that will be raised, and the possible risks for investors. Thus, investors must go through of the DRHP before investing in an IPO.

2.
Utilization of the Proceeds: It is very important to check how the proceeds raised from the IPO will be used. If the company says only debt will be repaid, then it might not be an attractive choice to consider, but if the company plans to raise funds to partly pay debt and expand the business or use it for general corporate purposes, then it shows that the fund will actually flow into the business, which is good for an investor.

3.
Understand the Business: Before investing, one should understand the nature of the business the company is in. Once she has understood the business, recognising the new opportunity in the market is the next step. Because, the magnitude of the opportunity and the company’s capacity to capture market share can make all the difference when it comes to growth and shareholder returns. On the flip side, an investor should stay away from an IPO, if the business activities are unclear as an investor.

4.
Promoter background and management team: An investor should closely check who is running the company. It is important to take a look at the promoters and managers of the company, who play a key role in all its operations and functions. The company’s management is responsible for driving it ahead. The average number of years spent by the top management in the company also provides an idea about its working culture.

5.
Company’s potential in the market: With increased awareness about the company around the time of an IPO, investor can analyze the potential of the business in its market to understand the future prospects. If the company performs well after raising capital, investors will gain high returns on the investment made during the IPO. The company that comes out with an initial public offering should have a good business model to sustain in the future.

6.
Key strengths and strategy of the company
: Investors can figure out the key strength of the company from the DRHP. One should also try and find out the company’s position in the industry it operates in. By reading more about the company, its positioning and strategies, one can have an idea about its future prospects of the business.

7.
Financial health and valuations of the company: Financial performance of the company needs to be checked in the context of whether its revenues and profits are growing or falling over the past few years. If the revenues and profits are increasing, it would be a good investment. Investors should try to understand the company’s financial health before buying an IPO. One should also check the valuations, because the offer price may be undervalued, fairly valued or overvalued, depending on the industry parameters and profitability ratios.

8.
Comparative valuation of the company: Investors should closely study the peers of the company. The DHRP will have comparisons with the peers –- both on financial numbers and valuations. One can look at the comparative valuations to check if the company’s valuations are in line with its peers or not.

9.
Major risk factors: Investors can figure out the risk factors from the DRHP. Reading the risk factors is vital to ascertain if there are any major concerns or risks associated with the company. At times there are certain litigations and liabilities, including contingent liabilities, which can pose a threat to the company’s future business prospects.

10.
Investors’ Investment Horizon: An investor should have a clear investment horizon. One has to be clear if she is planning to invest in the IPO to make a quick profit on the listing day or does she want to hold the shares longer. Because a short-term strategy would depend on current market sentiment, whereas a long-term one will depend on the fundamentals of the business.

Besides, an Investor should do her own share of research. If she believes in the long-run growth potential of the company, only then should she consider investing in the IPO. Do not evaluate an IPO based on grey market premium. IPOs can sometimes mean great opportunities to buy a share at a price that one can call a steal. So if one comes across a company that is valued below what it is actually worth, one should surely make use of that opportunity. However, one should invest in an IPO only if it is in sync with her financial goals and risk appetite.

The stock market is all about timing – when you enter the market and when you exit it. Sometimes, the timing is right during the IPO and sometimes, it’s better to wait. Make a decision depending on how much risk can you take and how good the fundamentals of the business are with respect to its valuation. Be sceptical, When it comes to the IPO market, a sceptical and informed investor is likely to fare better.

(DK Aggarwal is the CMD of SMC Investment and Advisors)