How to Analyse an IPO
The year 2021 has been a blockbuster year for IPOs. In 2021, 65 companies went public on leading exchanges, and several more were listed on smaller exchanges. It is predicted that 2022 will follow a similar trend. If you want to invest in one, you need to know how to analyse an IPO.
What is an IPO?
Before going into the details of analysing an IPO, you need to know what an IPO is. Here's a rundown of an IPO for beginners:
- An IPO or an initial public offering is when a company offers its share to the public for the first time and lists its shares on a stock exchange to trade.
- Companies go public to raise money for various reasons, including repaying debt, growth and expansion, mergers and acquisitions, etc.
- You can think of an IPO as a beginning of a new chapter. Whether you want to participate in this new company depends on whether you find value in the IPO.
Components of an IPO
An IPO can be primarily broken down into two parts – Fresh Issue and Offer for Sale.
A Fresh issue is when a company issues new shares and sells them to the general public during the IPO. An Offer for Sale is when existing promoters or investors in the company divest their stake.
It is essential to know the difference between the two because it has a material impact when you analyse an IPO.
A company may also have anchor investors where they sell a block of shares before the official IPO to build the confidence of retail investors. However, shares offered under this scheme have a lock-in period of 30 days.
Additional Read: Can I apply for IPO without a Demat account?
IPO Buying Guide
Now that you understand what an IPO is and how it works, let's get down to the nitty-gritty of analysing an IPO. Here are things to look out for when investing in an IPO:
1. Reason for going Public
One of the first things to look into is why a company is going public. Is it for growth and expansion, capital expenditure, to pay off debt or simply because it doesn't have enough money to run its day-to-day obligations? If it is the latter, it may not be wise to invest in the IPO. You can find all the information about why a company is going public in its Draft Red Herring Prospectus.
2. Company Financials
The next thing to look into is whether the company has been generating reasonable returns over the past few years. Dig into the business's revenues, profits, and cash flows to understand its financial health. If its revenues and profits have consistency and an upward trend, it may be considered as a good sign. If they are falling and inconsistent, you need to be careful.
3. Company Valuation
A company's valuation is its current or projected worth based on its profitability, growth prospects, industry outlook, etc. Before you invest in an IPO of a company, you need to consider its valuation. You can make a fair comparison with its listed peers and see whether the IPO price is justified or not. A company may be reasonably valued, under-valued or over-valued. Under the first two circumstances, there is a chance that your investment will pay off. If a company is overvalued, chances are its prices may drop after it goes public.
4. Growth Prospects
Once you have analysed the basics of a company, including its purpose for raising funds, financials, and valuation, it may be worth looking at the industry and the company’s growth prospects. You are investing in a company's future. If it has the potential to grow, either organically or inorganically, then chances of your investment growth will also increase.
Another valuable metric to consider is how the subscription for the issue is. If a company is undersubscribed, the market does not have enough faith in the company. So it may be wise to stay away. On the other hand, if there is good demand, it may be worth investing in the IPO. But this can’t be the sole factor to decide.
6. Management Details
Finally, you also need to know the performance history of those at the company's helm. A company's management can dictate the direction in which a company moves. Strong leadership means you can be sure that the company is headed for success.
Additional Read: How to track upcoming initial public offerings (IPOs)
Investing in an IPO can be pretty daunting, especially for the first time. This is why knowing how to analyse an IPO and using a trusted IPO buying guide to do the same can assuage some of those fears. IPOs can be a great way to cash in on a company's growth, if you know what you are doing.
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