Explained: All about investing in IPOs

It is not possible to run through news headlines and not come across the upcoming IPOs (initial public offers). This monsoon season, it’s raining IPOs in India. As many as 40 IPOs have already been completed in the last seven months, compared to 33 in the whole of 2020 and 49 in 2019.

Despite the impact of the Covid-19 pandemic, it seems the country will have a record number of IPOs this year.

Let’s understand the basics of IPO investing.

What is an IPO?

An IPO is the sale of shares to the public for the first time. Before an IPO, a company remains privately held, with a limited number of shareholders. However, after the IPO, the number of shares increases manifold as people like you and me and other institutional investors purchase shares of the company. With this initial offering, the company gets listed on the stock exchanges, facilitating buying and selling of shares. An IPO also provides exit options to the company owners and the initial investors through an offer for sale and compensates them for taking the early risk in the new business.

How to apply for an IPO?

As a retail investor, you may apply for the IPO either through your bank or through a broker, who will facilitate the IPO application process for you. For collecting application money, banks have an Application Supported by Blocked Amount (ASBA) facility. Some brokers facilitate IPO investments via the UPI mandate. In both cases, the application money is blocked until the share allotment is finalized and refunded if the application is rejected. At the time of application, the shares offered may either be undersubscribed or oversubscribed. When oversubscribed, the allocation of shares is not guaranteed, and in case of no allotment, the application money is refunded or the blocked funds are released.

Also read: What retail investors must do to make the most of the IPO frenzy

What are IPO investment risks?

Many companies have opted for IPOs since the end of 2020, primarily because of the impact of the COVID-19 pandemic on business and exuberant stock market activity. Analysts suggest that companies are going public due to the abnormal performance seen in the stock markets and higher participation of first-time investors, including high net worth individuals. Social media hype may entice you towards listing gains. Investors hope to make quick gains by selling the shares on a listing day as shares are perceived to be listed at a much higher price than the issue price. Around 60 percent of the investors take part in the IPO for listing gains alone, and only a few stay for the long term.

It has been observed that the majority of IPOs in the last decade (about 70 percent) didn’t give either listing gains or current gains, or both. This suggests that investors should forgo the opportunistic short-term investments and get past the over-hyped listing gains. You need to analyse the company before deciding to invest in the IPO.

Also read: Why you need to be careful while investing in IPOs

How must you analyse an IPO?

Analysing a listed company with a considerable amount of historical data is challenging enough, and it becomes even more problematic when it comes to a private company going public. The only source of data about such companies is their red herring prospectus (RHP) or the draft RHP. Thus, this is the document that needs to be scanned for opportunities and risks. It will give all the information from the names of the promoters, the amount they want to raise, the details of the fresh issue, and the offer for sale.

As an investor, you must look at the objects of the offer; this states the utilization of funds. These can be for organic growth, which is generally a good thing, or for reducing the debt, or a simple exit opportunity. Then, evaluate the business model and background of the company, the critical industry parameters (market size, potential growth, regulatory risks), and financials available for the past three years. Additionally, you may also look at the litigations, capital structure, and valuation of the company.

All in all, you should carefully assess whether the company’s profile fits in your portfolio, given your investment objectives and financial goals. Always do your research before investing and do not fall prey to social media puffery.