Things to keep in mind when you hear about the next big IPO

Wondering about upcoming IPOs? Here are some things that you should keep in mind.

Aug 25, 2020 07:08 IST India Infoline News Service

Initial Public Offer, IPO
While investing in an IPO might seem like an easy way to make short-term gains, it is hardly ever that simple. There have been plenty of instances where IPOs of fundamentally strong, well-known companies have failed to make a mark. So, investing in an initial public offering warrants a different strategy when compared with buying stocks in the secondary market. There are a host of factors that you should consider and things you should keep in mind. Let’s take a quick look at some of these aspects.

The prospectus

When you hear about an upcoming IPO, the first thing that you should do is read through and analyse the company’s prospectus. The prospectus is your primary source of information about a company that’s coming out with an IPO. It is basically an information booklet that contains every vital piece of information about the company. In addition to that, it also specifies the objectives of the company, includes its financial information over the years, the key managerial personnel involved, important legal disclosures, and what it plans to do with the proceeds of the IPO.

By thoroughly analysing the prospectus, you can not only acquaint yourself with the company’s business, but also get a fair idea of its financial performance and future growth prospects. This exercise is highly essential as it can help you make a decision about whether or not you should invest in the IPO. 

Company research

Information on companies that are yet to be listed on the stock exchanges may be a little hard to come by, but that’s all the more reason for you, as a prospective investor, to get to know this information. Adequate and comprehensive research on the company and its background is essential before you even consider investing in its initial public offering. Typically, company research involves financial performance analysis to a large extent. However, your search shouldn’t end just yet. There’s another major factor that you should consider while conducting research about a company - corporate governance.

Your focus should also be on ensuring that the company coming out with an upcoming IPO has a clean corporate governance record. Any defaults or lapses in this aspect should be taken seriously as it can dent the company’s future. Corporate governance research can help you determine whether or not the initial public offering is a suitable investment opportunity.  

Do not give into the hype

This is arguably the most important thing that you should keep in mind whenever you hear about an upcoming IPO. A major part of the initial public offering of a company is marketing. In order to attract the public into investing in an IPO, companies indulge in extravagant marketing techniques and typically spend lakhs to crores of rupees on this. They occasionally resort to using exaggerated statements to appeal to the public.

Some companies even use certain analyst reports to back up their claims. However, if you’re thinking about investing in an IPO, it is important to not give into the hype. Instead, it is a good idea to disregard the marketing strategies used by companies and instead conduct your own analysis to decide on the stance that you’re going to adopt when the initial public offering opens up. 
 
Share valuation

Another important thing that you should consider when you hear about an IPO is the valuation of the shares of the company. Typically, companies going for an initial public offering tend to overvalue their shares. This is especially true with respect to companies that are already quite well-established and well-known to the public. While fixing the price band, companies tend to charge a premium over the original value of their shares.

And so, the onus is on you to determine whether the asking price is fair or overvalued or undervalued. You could use comprehensive valuation techniques such as the DCF method to analyse the intrinsic value of the shares. Or alternatively, you could use the price to earnings ratio or the price to book ratio methods as well. You could also compare the valuation of the shares with that of the company’s competitors to determine if the asking price is worth paying for.     

Waiting is a good thing

Some investors are very quick to apply for upcoming IPOs as soon as they get wind of it. However, when it comes to investing in an IPO, patience sometimes holds the key to a good strategy. You don’t always have to be the first to apply. If the initial public offering is from a good, fundamentally stable company with strong growth prospects, you could always catch it in the secondary market once the initial furore subsides.

Also, by waiting till the IPO hits the secondary market, you get to analyse the market movement and gauge the demand for the stock before investing in it. Some IPOs of attractive companies may occasionally be listed at a discount to the cut-off price or experience a deep correction in the few days after the listing. By waiting patiently on the sidelines, you can avoid this volatility and protect your investment. 

Conclusion

The decision to invest in an upcoming IPO is an important one that involves a great deal research. Therefore, it is a better idea to stay on the cautious end of the spectrum. Also, ensure that you always stay informed and base your decisions on your objectives, goals, and your levels of risk tolerance. This way, you can increase your chances of success in the long run.

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