How to analyze an IPO?

Every business that wants to fund its operations or scale in the future has one thing in common: they all need cash. The cash is required to fund its current operations and fulfill the need to expand and increase profitability. A company can use the revenue to fund its day-to-day operations. But what about growing the business and achieving expansion goals? Expanding the business requires a large number of funds as the company may need to invest in infrastructure, human resources, or acquire new businesses.

The first alternative for a company to get cash is to take a bank loan. However, companies feel bank loans are tough as they require collateral and are limited to a certain amount. The second and the most widely used way for companies to raise capital is through an Initial Public Offering.

What is an Initial Public Offering?

An IPO, or Initial Public Offering, is when a company sells its shares to the general public for the first time. The shares, previously held by the company executives, are offered to the common people in exchange for money or capital, which the business may use for expansion purposes or to pay off debt. Once the IPO process is complete, the company is declared publicly listed, and its shares can be traded in the open market.

Once a company becomes publicly traded, a part of its ownership is sold to investors. Typically, a company initiates IPO for the following purposes:

• To infuse fresh equity capital.
• To facilitate the trading of its assets.
• To raise capital for various requirements.
• To monetize the investment of its private stakeholders.

What is Fresh Issue in IPO?

A Fresh issue is a process through which a company issues new shares of the company and sells them to the general public during the Initial Public Offering. For example, a company has 50 shares and a profit of Rs 100. Currently, the company’s EPS (earnings per share) is Rs 2 (100/50). Now, the company wants to raise Rs 30 through an IPO and issue 10 shares of Rs 3 each.

However, because of the new shares, the EPS will now be Rs 1.66 (100/60) as the shares are 60. This is how a fresh issue works.

What is an Offer for sale in an IPO?

An offer for sale is the process through which the company sells the shares held by the existing promoter/investors of the company. For example, suppose ABC firm holds 70% of company XYZ. Now, it wants to lower its stake to 50% and wants to sell the 20% to the general public. In this case, the company may issue an offer for sale for the 20% stake. The money received in an Offer for Sale (OFS) is used by the promoter/investor selling the shares and not the company, unlike in a fresh issue.

How to analyze an IPO?

Applying to IPOs can be tricky. Some may open at a premium, or some may open at a discount. Professional investors use various indicators to analyze and ensure the company is fundamentally strong and good for investing. The factors to analyze before applying to an IPO are as follows:

• Financials: The first thing you should look at is the financials of the company. Analyze the past five years' performance of the company to ensure that it has been profitable. Furthermore, the company should not have a huge amount of debt.
• The Purpose: While analyzing, you should read the Red Herring Prospectus of the IPO issue. The RHP contains information about how the company will use the money raised in the IPO. Preferably, it should be used for expansion and not to pay off debt.
• Demand: For any IPO, news about its subscription status comes daily. It defines how many investors have applied to the IPO. You can avoid an IPO if you see that the IPO is undersubscribed, meaning that investors do not find the company good for investing in.
• Future Prospects: One of the most important factors while analyzing an IPO is the company’s plans. You should ensure that the company wants to use the profits to expand and is at par with its competitors with its plans for new products and services.

Now that you know how to analyze an IPO, the next step is to open a Demat and trading account. These two accounts are mandatory for you to apply to an IPO. You can open a free Demat and trading account by visiting IIFL’s website or downloading the IIFL Markets app. After the accounts are opened, you can apply to IPOs online through IIFL’s proprietary trading software, Trader Terminal. This online facility brings the bidding process to your fingertips, enabling you to avoid the hassles of filling out forms and thus, minimizing paperwork. IIFL also provides news and in-depth analysis of the upcoming IPOs on the Trader Terminal and the website.