What an investor should check before investing in IPO?

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What an investor should check before investing in IPO?

IPO is the first sale of shares by a company going public. IPOs give an opportunity to the investors to make an early entry into the stock to reap the benefits of a company’s/Issuer’s growth journey. An investor may benefit in the form of listing gains and long term appreciation in the stock.

An investor should always take decision after analysing the potential risk and returns of the Issue. This can be done by the following checks so let’s look at What an investor should check before investing in IPO?

Understand the business of the company

First of all one need to check the business activity of the issuer. The product portfolio of the Issuer and the end use of the products need to be understood. One should know about the key customers of the company and their business continuity with the company needs to be ascertained. This information about business is available in RHP filed with SEBI. Typically, every Issuer tries to convince the prospective investors by presenting its business model to be unique therefore its pertinent for investors to make a sound and learned decision through his own research/findings.

Check on Peers of the company

This is very crucial check as it throws a light on the competitors of the company. Peer comparison identifies the strengths and challenges of the company/issuer when compared to its peers. Certain parameters like P/E ratio, revenue generation ability, debt to equity ratio and other factors like operating efficiencies are considered for peer comparison. However, the companies cannot be compared on an apple to apple basis.

Analyse Valuation of the company

One needs to assess the valuation of the company and whether the price band offered by the company appears attractive or not. The valuations of the issuer may be stretched which leaves a little on the table for the investors while many IPOs may be attractive that gives gains to the investors. Price bands offered must be analysed with the price to earnings and price to book value to arrive at the fact that whether the prices offered are justified or not. P/E and P/BV should be compared with the industry average to reach a conclusion.

Check Promoter and Management track record

Background of the promoter is very important in analysing an IPO. It should be ascertained whether the promoter is making an exit from the company through an offer for sale. A full exit by the promoters or if an IPO constitutes major portion as offer for sale, it might be a cause of concern for the investors. Too much drawing by the promoters in the form of profits, excessive dividends and related party transactions highlights any of the red flags.

Financial Performance of the Issuer

Last but not the least, financial review is a very important element to rate an IPO. Consistency and sustainability of revenues and profits for at least three years are the key factors to be considered to judge the Issuer’s financial stability. One can study the key financial ratios like profitability margins, debt to equity and return on net worth to assess the creditworthiness of the Issuer.

Hence an investor can take an informed decision by performing the above checks. Some IPOs may give short term gains and others might be viable for long term. Hence investors may decide accordingly depending on their investment objective and risk appetite.


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About CA Priyanka Choudhary Jain 122 Articles
Chartered Accountant & an experienced credit analyst. She has worked with CRISIL as a Senior Credit Analyst on rating assignments including business & financial analysis in Corporates as well as the Public Finance Sector. Please mail your queries, feedback, and any suggestions to her on info.financepost@gmail.com

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