Part 9 of the Moneycontrol Classroom, equity module. Here we will seek to understand what IPOs are, how to subscribe to one, and the advantages, if any, in investing in them. The link to previous modules can be found at the end of the article.
What is an initial public offering?
An initial public offering or IPO is an offer of shares to the public by a company looking to list itself on a stock exchange. The company coming out with an IPO could be looking to raise fresh money, and/or to allow existing investors to sell their holdings either wholly or partly.
How do I subscribe to an IPO?
To subscribe to an IPO, you need a demat account. Subscriptions can be done online. On your demat account, there is an option to invest through ASBA (Applications Supported By Blocked Amount). Essentially, a portion of your money from your savings account would be blocked for investments in the IPO. At the end of the subscription period, based on the investor response to the IPO, you would be allotted a certain number of shares. This may be less than or equal to the amount you applied for. Once the shares are allotted, the corresponding amount will be deducted from your bank account.
Some of the smartest investors avoid investing in IPOs. Why is that so?
The price of the IPO is fixed by the company issuing the shares and the investment banker. IPO valuations are a function of market sentiment. In a bull market, IPOs tend to be overpriced. Rarely is the issue undervalued. There is no way for investors to control price discovery (fair pricing) in an IPO.
What are the key parameters I should be looking at while investing in an IPO?
The most important document to evaluate while investing in an IPO is its red herring prospectus. This is a document that needs to be filed with the Registrar of Companies before the company goes public. It would contain relevant financial information about the company. In terms of parameters, it would make sense to review the cash flows and dividend history. It would also be worthwhile to compare the company’s valuations with its peers.
If there is massive oversubscription in an IPO, would I be better off avoiding it?
Subscription should not be an investment criteria. Subscription only indicates the market’s interest in the IPO. For a serious investor, valuations, historic earnings, and future earnings should be the investment criteria.
Conversely, if there is too little interest in an IPO, should I skip investing in that IPO?
Same as above.
Is it a good idea to subscribe to an IPO purely for listing day gains?I have seen people borrowing funds to invest in IPOs for listing day gains.
This strategy is more speculation than investment. The outcome may or may not be favourable. Even seasoned investors should use leverage (borrowing for investments) judiciously.More in this series:Why markets exist, and should I invest in stocks?
Starting your stock market journeyCan I get rich fast by investing in shares, and other questionsHow to open a Demat account and select a broker
Dealing with the stockbroker
Where should I invest and how?The author is Chief Ideator at ithought, an investment advisory firm.