Chapter 14: IPO Investment and Advantages - Part 2

Robert Toru Kiyosaki, the author of the #1 personal finance book of all time – Rich Dad, Poor Dad and the owner for the financial education company - The Rich Dad Company said –

“Before you invest in something, invest time to understand it.”

So, with that in mind, let’s take the time to understand what are the advantages of investing in an IPO:

Advantages of investing in an IPO

First-mover advantage: It allows you to buy the company's shares at an attractive price since the price of the shares may go up in the secondary market.

Achieve long term goals: Investing in an IPO is basically investing in equities, and investing in equities for the long term may help your money grow substantially and help you meet your long term goals.

Transparency: The information regarding the company, like its history, future plans and price, is publicly available and on a real-time basis on the official site of the stock exchanges where they have been listed. This will help you make a well-informed investment decision.

Opportunity to invest in good unlisted companies: An IPO offers investors a chance to invest in good and growing companies entering the market through the IPO route. Many of these companies are available at a reasonable price during IPO compared to the post listing price. Indigo Paints, Nureca Ltd. MTAR technologies, etc., are few examples where investors got a good listing gain.

What would you need to ask and know before investing in an IPO?

And, more importantly, and how you can avoid potential risks while investing in an IPO?

Here’s how.

Things to know before investing in an IPO

• Know more about the business

Warren Buffet attributes his success to staying within his "circle of competence". He is of the opinion that if he cannot understand what the company is doing, it is likely that many others may also have the same challenge — and therefore he stays away. You can use the simple yet vital piece of advice from Warren Buffet when investing in an IPO. If you do not understand what the company is into and its business, that should be the first red flag. Look in the company’s prospectus to know what the product or service is all about and the problem they are serving or the market they are filling. Once you have a clear idea of the business, you can identify the company's market opportunity and its ability to capture market share when it comes to returns and growth.

• Evaluate the management structure

Taking a close look at the company management can give you a good idea of the company’s prospects. Find out if the management has had knowledge and experience of working in the same industry, its area of functioning, the number of years in the company and more. Do check for any litigation against the company or its promoters. 

• Look into the risks

By now, you would know that every investment comes with a degree of risk. So is it with an IPO. You can find company specific risks within the prospectus to know for sure whether it needs to be considered as an investment.

• Check the valuation

To know if the IPO is fairly valued, look at its peer-listed companies and compare its management, competitive advantage and growth potential. If the issuing company does not have any listed peers, then you should check the P/E ratio, earnings growth, Return on Equity (RoE), etc. that will help you in arriving at a decision. Keep an eye on the quality of earnings as it is more important than the quantity.

You will learn more on how to evaluate a stock in the advanced module.

As with all investments, your investments in an IPO should also depend on your financial goals and risk tolerance. While market hype, publicity and peer recommendation of popular IPOs can be enticing, conduct your own share of research before investing in the IPO.

Additional Read: How an initial public offering (IPO) is priced?

Summary

• Having a good idea about your financial goals and risk tolerance will give you a clear picture on the right kind of IPO to invest in.
• Conducting due diligence about the IPO before investing can be a smart move.
• Some ways to avoid potential risks before investing in an IPO is to know more about the business, evaluate the management structure, understand its risks, check the evaluation etc.

Did you know that any action the company takes could impact you as a shareholder? We find out more about corporate actions in the next chapter.

Disclaimer – ICICI Securities Ltd. ( I-Sec). Registered office of I-Sec is at ICICI Securities Ltd. - ICICI Venture House, Appasaheb Marathe Marg, Prabhadevi, Mumbai - 400 025, India, Tel No : 022 - 6807 7100. Please note, IPO related services are not Exchange traded products and I-Sec is acting as a distributor to solicit these products. All disputes with respect to the distribution activity, would not have access to Exchange investor redressal forum or Arbitration mechanism. The contents herein above shall not be considered as an invitation or persuasion to trade or invest.  I-Sec and affiliates accept no liabilities for any loss or damage of any kind arising out of any actions taken in reliance thereon. Investments in securities market are subject to market risks, read all the related documents carefully before investing. The contents herein mentioned are solely for informational and educational purpose.