It's raining IPOs right now and days are as busy as it could get for IPO players and analysts. A lot of people I know are applying in all the IPOs and I understand the reason behind this frenzy. Most of the recent IPOs gave good listing gain to investors, which gave a sense of confidence to retail investors and hence most of them are applying blindly as Stocks only go up!!
If you are also one of them then you can take an edge over most by just analyzing few things and then you can make an informed decision. Now, if you are applying just for listing gains, then this article might not help much as listing gains are purely based on sentiments and not necessarily on underlying business or fundamentals of the company. However, a company with good fundamentals and if available at reasonable price might give good listing gain and you can even hold that for long term. So, let me share the main points which I consider before applying in an IPO.
Understanding the business and risk factors
The first and foremost thing you should do before applying in any IPO is KYC. KYC here means Know Your Company. Go to company's website, check promotors profile, understand the business model, check out its products, understand how they make money, see the competitors etc. After this, you will have a fair idea of the company and its business.
Now, you should see the risk factors attached to the industry and the company. Few examples of these are given below:
- Legal cases against the company
- Default in repayment of debt by the company
- Major dependency on few customers
- Major dependency on few suppliers
- Operates in highly regulated industry
- High dependency on key employees
- Operates in industry closely linked to politics and political promises
Objects of the offer
This is one of the most important things while evaluating an IPO. If the object of the fund raise is to invest back that money into company in the form of capacity expansion/ new acquisition, then that's a positive point. If object is to repay debt, this is also a positive point but it depends as cost of debt is significantly low these days and diluting equity to repay a low cost debt might not be the best decision. However, if the proceeds of IPO are simply going into the pockets of promotors/ PE fund, then this is a negative for me as it's not going to improve the business and basically existing shareholders are offloading their share to en-cash bull market.
Basis for offer price
As they say, what you buy is important but at what price you buy is more important. So, even if the business is good, object of the offer is to re-invest the proceeds in the company but valuation are high, you might end up losing money or not making much in short to medium term. These kind of stocks will see a long period of price stagnation. Price will be range bound even when earnings are improving. So, how to assess this?
Well, PE ratio is one of the widely used metric to assess the reasonableness of valuation. See the PE ratio of the company and compare it with it's industry peers and you will have an idea whether the company is fairly priced or over/under priced. Price-to-sales could also serve the purpose if the company is loss making or into an industry where focus of the users is to see growth in top line and profit is secondary in near term.
If you are wondering, where can you find all these information, well management has prepared a document for you so that you can have all these information at one place and its called Red Herring Prospectus (RHP). One simple google search can give you this.
Best of luck and happy investing. I hope this will help. Please share your views in comment box below.
About author:
Manish Negi is a Chartered Account and an experienced auditor.
Twitter - www.twitter.com/camanishnegi
Right on time when it was raining IPO's! Specifically those points basis which i should evaluate my company. Surely very helpful!
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