IPOs generate a lot of excitement whenever they are announced. With the Nykaa fever just behind us, you must be wondering if you missed the bus. Here’s what you should know about an IPO before applying for one the next time it’s announced.
1. Understand what an IPO is – It is a process whereby a privately held company offers its share to the public for the first time. It is also when promoters, angel investors, venture capital firms, and private equity firms typically sell their stakes.
You should look at major stakes in the company: who is exiting and what part of the money is being raised to pay them? Is the company raising funds to finance growth prospects? Or is the company raising a large portion of the funds to pay off debts?
2. Read the DRHP (Draft Red Herring Prospectus) – We understand that the DRHP is a lengthy document and new investors can find it daunting but investors should definitely go through the prospectus to understand the following.
Why is the company going public? What will it do with the funds raised? What are the risks associated with the business? What is the revenue model of the business? What details can you find in there about the company’s management and financial statements? Who are the company’s major competitors?
DRHP lists down all the information you will need about the company.
3. Understand the business – Try to avoid the urge to invest just for the listing gains or because someone has been talking about it.
If you are indeed going for the listing gains, you should have a clear strategy. If you aren’t, invest only when you understand the company, its revenue model, and are confident of the company’s market & its products & services.
Go through management discussion and analysis and look at the key strengths of the company and also the position of the company in the industry in which it operates.
Remember that everything depends on the company’s ability to generate revenue because this, in return, will increase the wealth of the shareholders – your wealth.
4. Look at the merchant banker – This is not a major consideration but skepticism can pay off in the IPO market. You should look at the merchant banker and its business. Are they reputed?
Merchant bankers are the ones doing the due diligence of the company, preparing the DRHP, and making sure everything is in order for the IPO. Highly reputed merchant bankers are in a position to pick and choose companies they underwrite.
5. Valuations – Even though merchant bankers spend a lot of time valuing the company, in the end, it is shareholders who decide what the company is worth.
The DRHP lists down the valuations & financials of the peers. Check whether the valuations are in line with the peers or not. Look at the revenue and operating profit multiples – which will give you some idea about where the company stands compared to peer valuations or look at the growth prospects the company is quoting to figure if the valuations make sense.
You can also read media reports or the analysis by valuation gurus to make sense of the valuations.
6. Be skeptical in every part of your research. IPOs are generally always blown out of proportion. There is very little information available to the public, and there is a lot of uncertainty.
Remember when you are buying equity shares you are buying every possible business risk associated with the company. The DRHP, brokerage reports, media reports, company financials, revenue model, valuations, etc. help you a lot in figuring out the IPO.
However, it doesn’t mean you should take them at face value. Remember that companies list regularly but finding the gem is not an easy task.
We hope this information helps you in your investment journey and especially in the process of applying for the next IPO. Stay tuned for more tips, advice, and blogs like these and remain empowered to make the right financial decisions.
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– Nischay Avichal
