An Initial Public Offering (IPO) marks the transition of a privately owned company into a publicly traded entity. Hundreds of companies in India hit the market with their IPOs every year, but not every listing has made investors enjoy unexpected profits. There are some IPOs in the past whose prices fell dramatically on listing day or those that fell consistently after initially offering significant benefits. Let’s discuss some of the ways to analyse the upcoming IPO in India.
Tips to Evaluate Upcoming IPOs
If you plan to start your share market journey through an IPO investment, consider the following factors to avoid buying the wrong stock.
Check Company Background
Before investing in an IPO, begin by analysing the company’s background. Check its establishment date and review the milestones the company has achieved over the years. Understand the list of acquisitions the company has made and how they have benefited in boosting revenue and profit margins.
Also, understand the launch of new products and services and whether they align with the current needs of the customers.
Industry Analysis
Evaluate the industry in which the IPO issuing company operates. Determine whether it is a mature or emerging sector. Next, review the company’s position relative to its peers. If online information suggests that the company is a market leader, check the sales generated by its top-selling product. This will help you assess whether their price band justifies their unique selling proposition (USP).
Review Financials
When reviewing a company’s financials, start with the income statement. This document provides detailed insights into the company’s revenue and profitability over the years and quarters. If you notice that profit is increasing quarter-on-quarter but the revenue remains stable or is declining, it could indicate poor cash flow management. However, it might also mean the company is clearing its fixed liabilities to save on interest payments.
Don’t ignore the cash flow statement. It shows whether the company can sustain operations and invest in growth without relying heavily on external funding. Positive and consistent operating cash flow is a strong indicator of financial health. Additionally, check key financial ratios like debt-to-equity, return on equity (ROE), and current ratio for further insights.
Review Management
When assessing a company’s management for an IPO, evaluate their experience, leadership skills, and track record. Begin by researching the backgrounds of key executives such as the CEO, CFO, and other board members.
Look into their prior roles, achievements, and tenure with the company.
The most important consideration here is to check the percentage of promoter holdings and understand whether it will be significantly reduced. If not, this indicates that the leaders are confident in the company’s potential.
Understand the IPO
Once you are clear on all the above parameters, check why the company plans for a listing. If the purpose of raising funds from the general public is to clear hefty debts, you may choose to stay away from that company. However, if the majority of the funds raised are intended for setting up new plants, expanding into new locations, or anything related to company growth, you can consider trying your luck with that IPO if you can take some risk.
Market Sentiment
Market sentiment refers to the collective attitude or emotional state of investors towards the market or specific sectors.
To assess market sentiment, start by monitoring the overall economic conditions. A positive economic environment with stable growth and low interest rates generally leads to optimism, which can drive demand for new stocks.
Next, observe the performance of similar recent IPOs. If there has been a wave of successful IPOs with strong post-listing gains, the market sentiment will likely be more favourable towards upcoming IPOs.
Discounted Cash Flow (DCF)
DCF allows you to estimate how much a company’s future earnings are worth in today’s terms. It gives you an idea of whether the IPO price is fair or inflated.
To perform a DCF analysis, forecast the company’s free cash flows for the next 5-10 years. You can do this by determining future revenue, subtracting operating expenses, taxes, and changes in working capital, and adding back capital expenditures.
Next, select an appropriate discount rate. This can be the company’s weighted average cost of capital (WACC). This rate reflects the riskiness of the investment.
Finally, you calculate the terminal value. This represents the company’s value beyond the forecast period and discounts all cash flows to the present value.
Risk and Challenges
Investing in an IPO comes with its share of risks and challenges, and price volatility is one of them. IPOs often experience significant price fluctuations in their early trading days. Predicting how the stock will perform can be difficult regardless of the tool you use. While there is a chance of substantial gains, it can also lead to losses if the stock underperforms.
Additionally, many stocks have a lock-up period. This is the duration during which insiders and major stakeholders are not allowed to sell their holdings. Once this period is over, a large volume of shares is sold in many IPOs, leading to oversupply and dramatic price falls.
Tips to Get a Subscription to an IPO
Now that you know what to check when applying for an IPO, here are some tips to boost your allotment chances.
- Before applying for an IPO, confirm that your bank account has sufficient funds to cover your application amount. Inadequate funds may result in application rejection.
- Apply using the ASBA (Application Supported by Blocked Amount) facility, which allows banks to block the IPO amount in your account without debiting it until allotment.
- Submitting your application early increases the chances of successful registration. Avoid last-minute delays due to high server traffic or technical glitches.
- Open Demat account in the name of different family members to submit multiple applications. This increases your chances of allotment since IPO shares are distributed randomly.
- Retail investors often receive allotment for the minimum lot size first. Applying for only the minimum lot can improve your allotment chances, especially in oversubscribed IPOs.
- Check the grey market premium to gauge demand. While not a guaranteed indicator, a high GMP suggests strong investor interest, which can guide your decision to apply.
Conclusion
While investing in IPOs can present lucrative opportunities, it’s essential to thoroughly evaluate a company’s background, financials, management, and industry before making any investment decisions. Assessing market sentiment, understanding the purpose of the IPO, and conducting a Discounted Cash Flow (DCF) analysis can provide deeper insights into a company’s true potential. Remember, the inherent risks of IPO investments, such as price volatility and lock-up periods, require careful consideration.
