We bring you 5 most important things to read in an IPO prospectus, before deciding to invest.
As the great Indian IPO festival continues, investors should exercise caution and not get caught in the noise and hype surrounding these issues. In the week starting November 1, as much as 5 IPOs will be open for subscription. Further, the IPO calendar for the coming months also seems packed with at least 15-20 companies looking to list on the bourses.
In this scenario, it is advisable that investors read the offer document or IPO prospectus carefully and make a well-informed decision. However, these documents are typically quite technical and voluminous. Instead of feeling overwhelmed, investors can follow this simple guide to read the prospectus and assess the company adequately.
Where to find an IPO prospectus?
It is available across multiple sources, namely SEBI website, website of the company launching its IPO, website of the investment banker(s) of the IPO, your stock broker and also business news websites. A simple google search typed as ‘XYZ company IPO prospectus’ will lead you to the prospectus document. Download it for ease of use and navigation.
What are the 5 most important things to read in an IPO prospectus?
1) Overview of the company and the industry it operates in
This is where it all begins. Understanding the company’s business, its strengths and weaknesses provides some insights into its future prospects. Investors must try to gauge whether the company has a long term economic moat (competitive advantage) in place. Like Warren Buffet says, “Buy a stock the way you would buy a house. Understand and like it such that you would be content to own it in the absence of any market.”
Likewise, understanding the dynamics of the industry the company belongs to and an overview of its competitive landscape is critical. A prospectus contains information about the demand-supply mechanisms, future growth potential and trends witnessed in an industry. Moreover, watch out for any structural disruptions in the sector (e.g. fintech companies reimagining the BFSI sector or Ola/Uber affecting purchasing decision of personal mobility vehicles).
2) Financial profile of the company
Worry not, you don’t have to go through the detailed financials of a company, typically mentioned in section V of a prospectus. Instead, a quick read of the summary financial information in the Introduction section should suffice. The purpose of reading this information is to understand the revenue growth, margin profile, cash flows and balance sheet strength of the company. Some well established companies also have a consistent history of paying dividends. As a general rule, be wary of companies incurring losses regularly or having huge debt on their books. Also watch out for details around price to book and price to equity ratios, which indicate whether an IPO is valued reasonably.
3) Objects of the offer
Appearing in the Introduction section of the prospectus, it explains how will the company use funds raised via the IPO. A company’s plans to use the money for reducing the debt on its books and/or for expansion purposes is generally perceived as a good sign.
Read details about the experience, qualifications, expertise and track record of the company’s founders, directors as well as management team. These details help understand how the company’s strategies are implemented and also highlights the quality of corporate governance practices of the company.
5) Risk factors
This section appears in the beginning of the prospectus and holds very high significance. Here, the company explains various internal and external risks which can affect its business and financials significantly. While some risks such as impact of COVID might be general and apply to most peers, others are more company-specific. These include high dependence on 1 or 2 customers/industries or geographies, withdrawal of tax incentives, pending legal cases against the company/promoters, details about contingent liabilities, among others. A recent example is where independent decision-making of a government-owned company came under the scanner. The risk factors in the company’s IPO prospectus had clearly mentioned, that its businesses and revenues were substantially dependent on xxx government entity and that any adverse changes in that entity’s policy may adversely affect its business and result of operations.
The IPO prospectus is a treasure trove of valuable information and insights. Investors can make smart, informed choices by reading this document in detail.
The author of this article is Sheetal Agarwal