IPO Investment – Best Tips and Strategies

An Initial Public Offering or IPO can be lucrative for generating profit. However, only some get rewarded. Want to know why? That is because one needs to find the right company with the right valuation and strong fundamentals that will allow it to grow over time. 

But first, let’s learn what IPO means and why it is issued.

IPO is when a private company that wants to raise funds from the general public. The company utilises these funds to expand, develop its business infrastructure and sometimes also to pay off its debt. Newly listed companies need historical data to gauge their true market value. 

That is why it is important to know the best tips and strategies to pick the right IPO. 

Tips and Strategies to Pick the Right Share

IPOs are usually discounted to investors to attract public interest. Therefore, it has the potential to yield high returns. However, blindly investing in stocks may result in losses. Follow these pointers to minimise losses and invest smartly.

Conduct Market Research

Market research on emerging companies can be challenging, as they often need more statistics available to justify an investment. Furthermore, the firms that provide the statistics risk publishing inaccurate data or concealing defects and deficiencies.

It would help if you searched obsessively for past press releases, competitor analysis, and market demand for the product or service offered to gather unbiased stats. The IPO prospectus or RHP (Red Herring Prospectus) is a good place to start researching as the Securities and Exchange Board of India (SEBI) approves it.

The accumulated stats help you chalk out underperforming companies and invest in high-prospective ventures which can earn you potentially high returns.

Analyse the Draft Red Herring Prospectus (DRHP)

A company must submit a Draft Red Herring Prospectus (DRHP) to SEBI for approval before going public. Post the approval; a company gets listed for IPO.

A DRHP includes:

i. History of the company

ii. Promoter’s information 

iii. The objective behind going public 

iv. Risks associated

v. Plans to invest the raised capital

Therefore, you must thoroughly go through a company’s DRHP before investing in its shares. You can always refer to the official SEBI portal to access DRHPs. Furthermore, you can access this document from the company’s website, the stock exchange’s portal, newspapers, and financial magazines.

Know Where Your Money Is Going

Companies opt for IPO for two major reasons: growth and debt repayment. 

Corporations willing to invest the raised capital in business expansion, inventory upgradation, and Research and Development (R&D) might generate higher returns for their investors.

However, in some cases, businesses raise capital to meet working capital or to pay off pending debts. These investments are not progressive and thus do not contribute to their business growth. Moreover, as a company’s profits are directly proportional to returns for investors, such expenses do not yield higher returns for shareholders.

Sometimes, the company can use the funds for both business expansion and debt repayment. In such a case, analysing its financials becomes important. Moreover, it is also important to understand the impact of debt repayment on the cash flows of the company.

Analyse Management and Promoters’ Profile

Who would not want their invested capital to be in safe hands? To ensure this, you must check for a company’s management team, past accomplishments, and, most importantly, the promoter or owner’s reputation and expertise. It helps to determine the company’s stability and the efficiency of its management staff. You can check for the above information online or through the company’s website.

Determine your Investment Objectives and Risk Bearing Capacity

One must have a clear idea of what one wants to achieve from their investments, whether equity or any other asset. It is important to analyse one’s financial capabilities and risk appetite and never be too greedy for higher returns.

Keep an Eye Out for Lock-in Period

A lock-in period binds pre-IPO investors under a legal agreement to hold their shares up to a certain period. If these investors sell off their shares right after the lock-in period, that will signify a lack of confidence in the venture. Furthermore, promoters or insiders often know the company’s true business health and may opt-out before incurring any losses.

Compare Similar Businesses

To determine a company’s competitive advantage or moat value, you must compare its financial ratios to businesses of the same scale or field. These ratios include Price to Earning ratio (PE ratio), Price to Sale ratio (PS ratio), Debt to Equity ratio (DE ratio), etc. In addition, it helps to compare a stock’s market demand and profitability and assess whether it is undervalued or overvalued.

Diversify Your Investment Portfolio

If you are a beginner in the stock market with low risk-bearing capacity, you must diversify your investments in multiple IPOs. Diversifying an IPO investment portfolio can help you minimise risk, as even if one stock underperforms, the rest can compensate for the losses incurred. However, over-diversification may hinder your returns.

Final Words

As a stock market investor, you must understand market trends and demands. However, you can only develop these skills after some time. Stock market investment is diverse, and one must ride through the ups and downs to discover their true potential. 

Therefore, always trust your research, and build your skill set based on your failures and successes. The blog caters to an overview of what you must consider before investing in an IPO.

Frequently Asked Questions (FAQs)