IPOs: How to Find a Good IPO
If you are considering investing in the primary market, you must first understand the basics and financials of the company before applying for an IPO. You can get all the information about the company in the draft red herring prospectus.
However, going through bulky document may be a very tedious and confusing task. So what you can do is focus only on a few essential parts of the document, which will be good enough to understand the business and its prospects.
For instance, the introductory section of the document highlights all the essential facts like what is the company and its business all about, the size of the offer, future prospects as seen by the promoters and the risks involved in the investment.
How To Find A Good IPO?
With IPOs flooding the equity markets, investors are spoilt for choice. Knowing which is the best IPO to buy can be tricky. Here are some evaluation criteria to help you identify a good IPO to invest
Deciding on investing in IPO is a bit similar to how you choose your career. You need to do adequate research and spend quality time analyzing before you make a decision.
Therefore, it is important to have a checklist before you dive into the world of IPOs. On-ly if you tick those boxes should you go ahead and invest in an IPO. Let’s go through some of the things you should consider before investing in an IPO.
Investment goals
Before investing in IPO, you have to ask yourself some questions to discover what kind of strategy you should follow. This is because one cannot decide on what kind of an in-vestment decision is the right one for you unless your investment goals are clear.
Further, a lot of your decisions can only be judged based on your current investment portfolio. For example, if you are heavily invested in the small-cap sector, investing in an IPO from a small enterprise may make your portfolio even more lopsided.
On the other hand, investing in an IPO launched by a large firm may help bring some balance to your portfolio. Now let's discuss about 5 most Important things to analyze before applying any IPO.
5 Things to Analyze Before Applying An IPO.
1. Understanding the Business Model
Investors should understand what kind of business model the company has before investing in the Initial Public Offering.
Once they understand what kind of business the company is into, the next step is to recognize the new opportunity in the market.
The reason behind this is that the magnitude of the opportunity and the company’s capacity to capture market share can make a huge difference when it comes to the growth of the company and shareholder returns.
If the business activities of the company are unclear to the investors, then they should stay away from its IPO.
2. Strengths and Weaknesses of the Company
One should do the SWOT analysis of the company before investing in its Initial Public Offering.
The key strengths and weaknesses of the company can be analyzed from the DRHP. Investors should find out what is the company’s position in the sector in which it operates.
One should try to read about the company from various sources and also about strategies so that investors can study the future prospects of the business.
3. Pricing
Do not make an IPO investment just because the company is famous. The company’s brand name is just one ingredient that distinguishes the best IPO from others. Popular companies can price their shares higher than they are worth and have oversubscribed IPOs.
You can estimate the fair price of a stock through a competitor analysis. Price-to-Sales and Price-to-Earnings are two of the most commonly used multiples for this.
You can calculate these ratios by dividing the price of a company’s stock by its sales per share and net income per share respectively. Both these figures are given in the company’s income statement. If these ratios are higher than those of competitors, the stock may be overpriced. You should avoid such an IPO.
Of course, there are times when the shares are priced higher because the company is actually better than its competitors. A thorough analysis of the company’s history and future prospects will tell you if this is the case.
4. Analyzing Management and Promoter Background
It is important to check who is running the company as they are the backbone of the company.
Investors should look at the promoters as well as the managers of the company as they play an important role in all its operations and functions.
The management of the company plays an important role in driving the business ahead.
One should check the qualifications and number of years that is spent by the top management in the company as it provides an idea about the company’s working culture.
5. Always Read the Prospectus
We've mentioned not to put all your faith in a prospectus, but you should never skip perusing it. It may be a dry read, but the prospectus, which can be requested from the broker responsible for bringing the company public, lays out the subject’s risks and opportunities, along with the proposed uses for the money raised by the IPO.
For example, if the money is being deployed to repay loans or buy the equity from founders or private investors, it may be worth giving the IPO a miss. This isn’t an encouraging sign and tells us the company cannot afford to repay its loans without issuing stock. Generally speaking, money that is going toward research, marketing, or expanding into new markets paints a much better picture.
In addition, one of the biggest things to be on the lookout for while reading a prospectus is an overly optimistic future earnings outlook. Over-promising and under-delivering are mistakes often made by those vying for marketplace success, so it’s important to read projected accounting figures carefully.