With the primary markets opening up again, there have been many initial public offerings or IPOs in the last three months. Recently, US equity markets witnessed America’s largest technology company’s IPO from Facebook. But investing in IPOs is not as simple as it seems, neither is it less risky. IPOs are not for the faint hearted investor; you need to do enough work before committing your money. Here are three key things you must look at before investing in an IPO. Remember that they are not the only things to look at.
Prospectus Details
Promoter background: Go through the details of who owns the company and its shareholding pattern. It will give you an insight into how the company is run. For example, if the company is mainly promoter-owned with no other companies or individuals having any shares, it indicates that the company is more or less driven by one person or a group of people. If the shareholding indicates that other entities, too, own a part of the company, it may show a more balanced approach to company affairs and decisions.
Financials: These are historical figures of financial performance. There are three main statements—balance sheets that show assets and liabilities and the overall financial position of the company; profit and loss account that show how much revenue and profits a company is able to make in a year; and the cash flow statement that shows how effectively the company is utilising cash it’s generating from business (or whether it is generating any cash or not).
Industry growth: It is important to know what kind of competition the company’s products face and its market position.
Risk factors: These will give you an idea of potential downsides. This section also lists out court cases pending against key personnel and the company, which is something one must keep an eye on.
Valuations
This is extremely important in determining the success of an IPO. It matters what price you have to pay to own a part of the IPO. Analysts have many metrics to assess whether pricing is accurate, such as price-earnings multiple, price-to-book value or PBV and market capitalisation. If the IPO is overpriced or expensive, there is a chance you may get to buy the shares cheaper after listing.
Merchant banker record
This is important in the context of valuations. Merchant bankers to an issue, among other things, help in pricing the issue. On the basis of analysis, research and investor feedback, they arrive at a suitable price for the share on offer. In the last 2-3 years, many shares listed via an IPO are trading substantially below the IPO price, thus long-term investors who subscribed to the IPOs have lost out. If a merchant banker has a consistent record for such issues, where prices correct a lot post listing, you should stay away.
