How to pick an IPO?

July 14, 2011   ·   0 Comments

The domestic stock markets have been through a spectacular rise over the last few months, and the trend is rubbing off in the primary markets as well.  There is a flurry of initial public offers (IPOs) and follow-on public offers (FPOs) by private as well as public sector companies.

www.stockssavvy.coma There are many takers for the good and reasonably priced public offers. There has been a good participation by individuals, high net worth individuals, domestic institutional investors as well as FIIs.  On the other hand, many offers struggled to get complete subscription due to over-pricing issues or weak fundamentals. Earlier, investors used to invest in IPOs in anticipation of listing gains. However, the primary market is getting more mature with time.

Objectives of IPO

These are some points you should keep in mind while deciding on investing in an IPO: This is one of the first points to analyse on a public offer of shares. Usually, the companies that go for public offers have certain objectives behind the offers. These include raising the funds for business growth, retiring/reducing debt, stake sale by some of the promoters etc.

Investors should analyse these objectives carefully and get an idea about the future of the business and company’s growth. It is important to keep in mind the expectations of future earnings’ growth of a company is the prime driver of its stock prices in the market.

Invest in IPO based on fundamentals

The stock markets are on a roll amid positives such as revival of the monsoon, strong global cues and improved industrial production numbers. The advance tax numbers and excise duty collections also indicate that the quarterly performance of most companies would be better than expected. The upbeat secondary market has had a rub-off effect on the primary market. Promoters who had postponed their initial public offer (IPO) plans last year are now looking at taking advantage of the renewed positive sentiments.

A good part of the year 2008 saw lack of interest in equity due to poor investor sentiments and declining markets. The IPO market thrives in a rising secondary market, hence the better part of 2008 hardly saw any major IPO issues.

Study prospects

As an investor in an IPO, it is extremely important to understand the business of the company and how it compares with its peers in the industry. The track record of the management, past performance of the company, risks that the company faces and the purpose of raising finance along with expected returns on investment are other crucial factors to be considered. The grade given by the credit rating agency may also be a good indicator about the company’s prospects.

Company may have good prospects but if all the positive factors are priced in completely, there may be little scope for the price to appreciate after listing. Also, an over-priced issue, however good the company may be, may correct to its fair price eventually.  By comparing the pricing with respect to peers in the industry, you may judge if the issue is underpriced or over-priced.

Finally, avoid falling prey to all the buzz and market stories. Also, over-subscriptions do not indicate that the listing price will be high, so steer clear of all such myths. Investing in an IPO is no different from investing in a listed company. All aspects of analysis and basics of investing should be applied to an IPO and you should subscribe to it only if the rational investor in you gives a go-ahead.

Pricing of the issue:

The pricing of an IPO is very important. Investors should look at various ways to determine the pricing of an offer. The simplest way is to read various reviews. Investors can do their own due diligence of an IPO by comparing its price with respect to its peers in the industry, checking various ratios, order books, future growth plans, risks etc. It is advisable for investors to look at investing in an IPO with a medium to long-term perspective.

Market sentiment

This is another factor that drives subscription of the issues. However, investors should analyses the reason for subscriptions of an offer carefully – whether driven by fundamentals or driven by speculation. Investors should not get carried away by the reports of subscriptions to an issue. They should concentrate more on the fundamentals and pricing of an issue.

There have been many over-priced issues being over-subscribed during good market conditions, but they lose value sharply after listing and result in heavy losses for individual investors.

Personal financial condition significant

It is always advisable for investors to invest only their risk capital in the markets. Investment in an IPO is also an investment in equity. Even if the primary markets are looking much better than they were a few months ago, it is not advisable to borrow money to invest in IPOs for the sake of listing gains.  Investors should keep in mind that even a large IPO may not list very high after the allotment as it draws a lot of liquidity from the market.

On the other hand, a good small IPO may get subscribed many times over and hence the allotment becomes very small, reducing the chances of a high listing gain. Investors looking at listing gains should also keep in mind that the stock markets are trading close to their all-time high and there are chances of a correction in the short to medium terms.

Rajesh Singla

Rajesh is the founder & CEO of Stockssavvy, Stocks analyst,financial advisor by choice,software engineer by fate,biker,gamer,cricket lover n enthusiastic person. He believes in doing things not just to get by but to get Ahead...

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