What To Do Before Investing In An IPO?

What is an IPO? 

An IPO, short for Initial Public Offering, is when a private company sells its shares to the public and makes these shares tradeable on the stock market. Private companies work in collaboration with investment banks and multiple other agencies to bring their shares to the public. There are a lot of regulatory requirements that need to be fulfilled, along with a lot of patience and marketing, before an IPO can be launched.  

There is always some element of risk involved with every IPO and you should always do your due diligence before investing in any of them. 

Now, let’s discuss some points you should consider before investing in an IPO :

1. Carefully read the Red Herring Draft – The DRHP, or Draft Red Herring Prospectus, is a document that is prepared as per SEBI requirements before any company wants to go public. This document is made available publicly and is an essential resource for any potential investor. The DRHP also expounds on how the organization plans to utilize the money that will be raised, and potential risks for the investors. Investors should go through the DRHP before putting their money into a new IPO. 

2. Use of the proceeds – It is vital to check how the proceeds raised from the IPO will be used. If an organization intends to only reimburse its debt with these funds, it’s probably not a great sign of things to come, but if it intends to raise funds to partly pay the debt, and partly to grow its business or to use it for general corporate purposes, it shows that the funds raised are being put back into the business, which is good news for an investor. 

3. Figure out the business – An investor should understand the nature of the business of a company before investing in it. Understanding the business allows you to better judge how a company will perform given its priorities. A company’s capacity and ability to increase its market share make a significant difference to its appeal since returns and growth depend on this. On the other hand, an investor ought to avoid an IPO if the business exercises are not clear.  

4. Who runs the company – An investor should always check who runs the company and has the power to make decisions. It is crucial to look at managers and key people of the company as they are answerable for its performance. The experience of the top management gives a glimpse into the company’s working environment. 

5. Look for a company’s potential – An investor should analyze the potential of the company and figure out future possibilities. If a company performs well in the wake of raising capital, investors will acquire significant returns on their IPO investments. The organization that you’re investing your hard-earned money in ought to have a good plan of action to sustain itself in the future. 

6. Relative valuation of the company – Investors should closely research the company’s competitive position. The DHRP will usually include a company’s comparisons with its peers, both on monetary numbers and valuations. An investor can look at the new IPOs’ comparative valuations to check if a company’s valuations are in line with its peers.  

7. Investment Horizon – An investor should have a clear understanding of the investment horizon before investing in an upcoming IPO. One must be clear, whether they are planning to invest to make a quick return or if they’re looking to hold these shares for the long term. A short-term strategy depends on current market sentiments while long-term ones rely on the fundamentals of the business. 

Timing is essential when you operate in the stock market. When you enter the market and when you leave it can make all the difference. Sometimes, the timing is right during the IPO and at others, it will be a smarter decision to wait. Make a decision based on how much you can make and how good the fundamentals of the business are as far as valuation is concerned.