Things You Need to Know Before Investing in IPOs

By  //  January 19, 2021

Investment in IPOs requires a lot of research and analysis before you make a decision. Here’s helping you to get a checklist of all the important factors you should consider before you dive into the IPOs world.

What Is an Initial Public Offering (IPO)?

IPO is basically the selling of shares or securities of a private company to the public in the primary market. Investors investing in IPO are among the first investors to purchase shares in the company. IPOs are divided into 3 categories namely retail, institutional and high net worth individuals (HNI).

Investors must go for subscription from qualified institutional buyers for the IPO, as it helps in tracing the quality and pricing of the issue.

A low level of subscription does not seem to be a strong proposition for institutional investors but a high level of subscription allows huge retail subscription and less allotment, making the whole exercise worthless.

According to the experts, investing in IPOs is no longer a good decision for retail investors. They should go for fundamentally strong and much established companies in high growth sectors.

Companies want to earn the maximum possible valuation without leaving anything for retail investors. In high subscription level issues, investors get few shares in allotment which is worthless and end up in blocking of investment for 10 days.

Types of IPOs

There are two types of IPO Pricing offered by companies:

■ Fixed Price-

■ Book Building – It has a price range

Fixed Price Offering 

The fixed price offering is pretty simple and straightforward, Investors can apply at a fixed price decided by the company in advance. When you participate in a fixed price offering, you agree to pay the full share price.

Book Building Offering 

The book-building offering has a price range, the company offers a 20% price band to investors on shares. Before settling the final price, investors can bid on the shares. As there is no fixed price set, investors can submit their bids for the number of shares and price they are willing to pay.

The lower level of price band is known as floor price and the higher one is known as the cap price. It is important to hire an investment bank to handle an IPO when a company decides to go public. Although a company can go public on its own, hiring 1 or more investment banks helps you divide the risk among the banks.

Buying an IPO

There are certain requirements one must meet to get the new shares. To buy shares, your broker must be a part of the initial offering or must meet requirements like experience, risk and investable assets as it is sometimes difficult to get the new shares.

Before investing there are certain factors that one should keep in mind. Let’s understand them in detail-

1. Understand the Business

Investing in a business is a waste if you don’t understand it. So, understand the business well and identify the market opportunities to make better decisions. When it comes to returns and growth, what matters the most is the company’s ability to capture market share and various opportunities.

2. Understand the Risks

Every investment is associated with a certain level of risk. It is important to understand the risk associated with any business before investment. Research on factors such as the number of competitors, current market environment and the quality of a product & services. Risk factor plays a major role in any type of investment.

3. Do your Research

Always start with reading of IPO prospectus and understand which sections are important to make an informed investment decision. You should be clear about their products and services they are providing. Google about their company and competitors, previous press release and overall industry growth.

4. Understand the Capital Structure

Before investing in any business, calculate if there are any signs of the long-term success of the company. Go through the list of current shareholders and well-known investors to know about the company’s goodwill. Also, make sure to look for performance shares as every new share will impact your holding value. Find out how much stake investors are retaining in the company after the IPO. Have a thorough reading of all the options included in the offer.

 Things You Need to Know Before Investing in IPOs

■ Go through the entire prospectus, past press release, reviews, and ratings provided by several brokerages and independent analysts.

■ Understand the business well and its prospects, turnover, financials and competitive areas.

■ Compare with peers to find out the company’s goodwill and have a thorough research about the point of product portfolio relevance, pricing capabilities, and cost margins.

■ Check the management team, lead managers and overall purpose of IPO.

■ The most important factor that one should not avoid is the positioning of the stock market. The current positioning of the stock market will determine the status of IPO.

Benefits of Investing in IPOs

■ IPOs allow fresh investors to invest in a company in initial days. With time, investment grows as the company grows.

■ IPOs are considered as the best option for long-term investment as it brings good returns in the long run.

Why are IPOs important for stock markets?

IPOs play a very crucial role in broadening and depth of the market. To provide stability and raise in liquidity, good quality listed entities provide several options for investors in the secondary market.

It can be simply understood with an instance- If a large sum of money is invested in buying few quality stocks, the cost will turn out to be very expensive. However, if the same amount of money is invested in buying a higher number of quality stocks, prices can be more even and the risk factor will be lower.

As IPOs involve a high level of risk and uncertainty, it is best to keep to the minimum. Investors need to research well before investing to avoid bad performance.

Take your time in understanding the business, risks involved, capital structure and various financial issues before making a well-informed decision on investing in IPOs.