Initial public offers are a risky investment route; the investor has no control over the price at which he buys the stock
Until a few years ago, initial public offers (IPOs) of companies created quite a lot of excitement and enthusiasm among investors. IPOs carried the promise of making investors a whole lot richer overnight, enticing them to take the plunge regardless of the fundamentals or valuations. Moneylife has always been sceptical of going for IPOs, maintaining that it is a riskier investment route.
This is simply because you have no control over what price you buy the stock at. Remember that promoters' interests are exactly opposite of yours. You want a cheaply priced IPO. The promoters want to sell it at as high a price as possible.
As it happened, many of these public offers suffered miserably, resulting in heavy losses. The result is that most retail investors today shy away from IPOs altogether. Retail subscriptions have dwindled and even employees don't want to put money in the companies they know inside out. Putting money into an IPO carries substantial risks but, if you must invest, extensive due diligence is critical. In fact, much more caution is advised in IPOs considering that most of them do not provide their financial history beyond what is mandated by the regulators. So, before putting in your hard-earned money in an IPO, do extra homework. What parameters should an investor consider while investing in an IPO?
Promoter Background: Check the reputation of the promoter and his previous ventures, if any. A foreign partner of repute backing the company is an advantage but Indian promoters are known to fix this as well. If there are too many litigations pending against any of the promoters, avoid the issue. Some of the really poor-quality IPOs shoot up after listing. Please do not regret. It is usually rigged and you have no way of knowing that. Another key aspect is to check the post-issue holding of the promoter. If it is too low, then you have reason to be circumspect.
Historical Performance: As with any other potential investment, evaluate the past performance (at least five years) of the company thoroughly - the rate of growth in earnings, profits, growth in market share, etc. Do not just go by the past one or two year's financials. These can be easily manipulated and distorted. They usually are, to make the issue look attractive.
Valuation: Do not look at the company's share price in isolation. Compare the price to earnings (P/E) multiple of the company with that of its peers (the lower the better). A higher P/E multiple is justified only if the growth prospects are visibly brighter. Most often, IPOs are priced too high. Remember, the company wants to sell its issue at as high a rate as possible.
Objects of Issue: Is the stake sale for financing new projects, undertaking expansion, making acquisitions, paying off existing debt or something else? While there is a lot of genuine hope around expansion or a new venture, they usually get delayed and the IPO money starts giving returns only later.
Risk Factors: Thanks to stringent disclosure norms, IPO prospectuses these days have a detailed listing of risk factors, internal and external, for the company. Reading these is a must and would be enough to put you off.
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This means access to other articles (outside the subscription period) are not included.
Articles outside the subscription period can be bought separately for a small price per article.
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The company's balance sheet:
If you want to be an investor, it's time to start reading and understanding a balance sheet. Pay attention to the topline and the bottomline, major variances; but most importantly, consider carefully the extraordinary items and notes to accounts. It's quite possible for a company to derive its revenues not from its main business, but from smart accounting entries.
The company's balance sheet:
If you want to be an investor, it's time to start reading and understanding a balance sheet. Pay attention to the topline and the bottomline, major variances; but most importantly, consider carefully the extraordinary items and notes to accounts. It's quite possible for a company to derive its revenues not from its main business, but from smart accounting entries.
Compliance record and litigations:
Find out whether group companies have been diligent in filing their returns to various bodies such as the stock exchanges and registrar of companies. The prospectus will disclose all major litigation cases filed against the company's directors and promoters, as well as against group companies. Avoid companies that are deeply mired in litigations.
Shareholding pattern:
It is important to know who the major shareholders of the company are and what their shareholding pattern will be after the issue. A huge promoter stake is not too desirable.
If a company has institutional investors as its shareholders, it means that a lot of due diligence has already been done on the company. Try to find out at what prices these pre-issue allotments have been made, and to whom and when.
It is also important to look at what the possible shareholding pattern will be after the issue.