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8 things to keep in mind while investing in an IPO as a retail investor)

8 things to keep in mind while investing in an IPO as a retail investor

0Comments December 03, 2020

The primary market has been abuzz lately, thanks to a slew of highly successful IPOs. The positive sentiment in the cash market has translated into greater interest for new issues – 16 companies have raised almost Rs 25k crore this year. Much is expected from the Burger King IPO, which is open from December 2 to 4.

If you plan to participate in the IPO action, here are 8 things you should consider before sending in your application.

1 – Do Your Research

While research is important for any kind of investment across asset classes, it is crucial while dealing with IPOs for the simple reason that information may not be as readily available as you think.

IPOs are offered by companies that are privately held and want to go “public”. Their past performance is not as open as existing publicly listed companies, who need to provide periodic financial disclosures. Private companies are also not tracked routinely or analysed. Hence, it is important to learn as much as you can about these companies before committing your funds.

2 – Check the Promoter Holding

It is important to also dig into the backgrounds of the promoters and see how much they will continue to hold after the IPO. A rule of thumb is: if the promoters hold a significant stake post IPO, it means that they believe in the company’s future earning potential.

3 – Probe the Prospectus

The prospectus is a sort of sales pitch by the company that wishes to go public. It provides a brief history of the company and a glimpse into the future. While you won’t find any explicitly negative aspects mentioned in the prospectus, it is important to go through it to understand the company’s vision.

4 – What is the IPO for?

The prospectus will talk about how the company plans to use the funds it raises from the IPO. This is important because it is essentially your money that they will be spending. Generally speaking, companies that plan to invest in areas like research or product development are better bets than those that plan to pay off old debts.

5 – Look at peers and the market

A good way of gauging a company’s future post its IPO is to look at the current and past performance of its peers that are already trading on the stock market. Since listed companies have more information available publicly, you can even look at their performance over the past few years and the state of the market. You can compare the projected earnings of peers with what the company raising funds has mentioned in the prospectus. For instance, in case of the Burger King IPO, the peers you should look at are Westlife Development (which runs McDonald’s restaurants through its wholly owned subsidiary, Hardcastle Restaurants) and Jubilant Foodworks (which runs Domino’s in India).

6 – Valuation

Valuations can be tricky for most retail investors when it concerns stocks that are publicly traded. Valuing an IPO can be a lot tougher. But some ratios to look at would be: Price Earnings (PE), Book Value (BV), Return on Equity (RoE), Operating Profit Margin (OPM) and so on. You should compare these ratios to the peer group to get a better idea of the company’s potential.

If you’re unsure what PE, BV, RoE or OPM are, refer the following bullets. Else, feel free to skip to Point #7:

  • Price Earnings: PE is one of the most used ratios while valuing stocks. It looks at a company’s stock price in relation to its earnings per share (EPS). The formula to calculate PE is:

Current Share Price / EPS

PE tells us how much premium the market is ready to pay over and above a stock's actual earning. A higher PE means the market is ready to pay more and expectations are already high from the company! Be careful with high PE stocks, because the company needs to deliver growth as expected, otherwise we can expect a correction in price.

  • Book Value: BV is the total value of the assets held by the firm minus its liabilities. Savvy investors use P/B (Price to Book Value), which is the Current Market Price of a share divided by its Book Value per Share.
  • Return on Equity: RoE is a metric that shows how well a company uses money it has raised from shareholders. It is calculated as follows:

Net Income / Shareholders’ Equity

  • Operating Profit Margin: OPM measures the profits a company generates from its operations and is expressed as a percentage. The higher the % the better. It is calculated as follows:

Operating Income / Revenue x 100

7 – Track institutional investor interest in the IPO

Large financial and banking institutions have better tools and resources than individuals to conduct research into companies. As an investor, you can take a cue from institutional interest in an IPO. Look at the QIB category of an IPO – if there’s a great deal of interest there, then you can assume that institutions find the IPO worthy of investment. However, do keep in mind that institutions do not have the same goals as individuals. Hence, while investing in an IPO, as with any other kind of investment, your needs and your plans must be your first priority.

8 – Be Cautious

It is not wrong to be cautious when dealing with IPOs, and a healthy level of scepticism might actually do you good.

While the rewards can be second to none, IPOs also carry risk, especially if you are in it for listing gains. It is advisable to invest in fundamentally good IPOs with a long-term horizon.

How to Apply for IPOs

Once you are ready to invest in an IPO, the next question that follows is: How exactly does one apply for an IPO?

A smart way to apply for an IPO is via UPI on a mobile app. You can apply for any IPO with a few taps using the Espresso app. It’s simple and hassle free!

Here’s a short video explaining the process.

Happy Investing!

Chandresh Khona
by Chandresh Khona

Product Offerings Head

A teacher, writer, travel buff and now Espresso's Product Offerings Head. Ten years here has allowed me to lead the digital team at Sharekhan. My true passion lies in stock market charts.

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