How to Analyse a Company Before Investing in Its IPO?

When a firm is launching an IPO, it makes a public issue of its stocks. For an investor, an IPO is often a thrilling investment prospect in a company at the initial stage. But thrill should be rightfully earned and go ahead with serious thought over whether it is worth investing in the IPO.

This blog is going to take you through IPO analysis, what to look out for,how to evaluate ipo, what reading materials to go through, and the risks. If you are a retail investor or prefer things in order, this article will provide you with the essentials of how to make well-informed decisions before you can invest in any IPO.

What Is an IPO and Why Do Companies Issue It?

An Initial Public Offering, or IPO, is the process of converting a privately held company into a public company for the first time through making its stocks available to the general public. The most common reason for issuing an IPO is to raise capital to grow the business, retire debt, or for other business enterprises.

When a company floats, it gets more transparent in its dealings and also tries to be accessed by a broader class of investors. IPOs can provide investors with the opportunity to become among the first owners of companies whose growth can be high. Yet, as in any investment, there are risks involved, and consideration must precede the decision.

Why Analysing an IPO Is Important?

IPOs are headline-makers and cause a buzz and oversubscription and volatility are the aftermath. They compel investors to invest in fear of missing out and thus FOMO, but careless investing is a big no-no.

Each IPO possesses its own risk factor — ranging from business operations to price. An IPO study is thus the cry for the hour. A thorough knowledge of the company's finances, growth strategy, competitive edge, and risk factor forms the mantra of a safe investment.

How to Analyse IPO?: A Step-by-Step Guide

Analysis of IPO includes studying the business fundamentals of the company, finance, management quality, and price at which it is issuing shares. The following steps are the most important steps to be performed and can be used as an IPO buying guide

1. Read the IPO Prospectus

The first and best source of information regarding an IPO is an IPO prospectus. Or the Draft Red Herring Prospectus (DRHP), as it is also called, is a detailed document filed with SEBI prior to the IPO. The prospectus is replete with material information regarding the business, company accounts, and reasons for undertaking an IPO.

Key sections to read:

• Business Overview: Observe the nature of the business, what it sells or makes, and where.
• Industry and Competition: Consider industry expansion and think about major players.
• Financial Statements: Review revenues, margins, cash flows, and leverage positions over the last three years.
• Use of IPO Proceeds: Ensure that proceeds raised are to be utilized for expansion, not debt repayment.
• Promoter and Management Background: Verify the qualification, experience, and shareholding of the promoters.
• Legal and Regulatory Issues: Verify any pending litigations or regulatory penalties that would pose a future risk.

Going through the IPO prospectus provides you with a better platform to know about the offer.

2. Assess the Financial Health of the Company

Reasonable financial analysis enables you to analyze whether the company is a sound financial company or not. Take into account:

• Revenue Growth: Gradual growth in revenues is a sign of even demand and scalability.
• Profitability: Monitor operating margin and net profit trends to assess efficiency.
• Cash Flow: Sustained operating cash flow is a sign of a healthy company.
• Debt Levels: Excessive debt levels are an alarm sign. Monitor the debt-to-equity ratio.
• Return Ratios: Return on Equity (ROE) and Return on Assets (ROA) ratios reflect management efficiency.

A healthy balance sheet and a good earnings path are signs of a successful IPO.

3. Read the Risk Factors of the IPO

There is a separate section on the risk factors of the IPO in all IPO prospectuses. It is the issues, which could be confronting the business.
Some of the typical risks are:

• Industry Risks: Decline in demand or regulation in the industry.
• Operational Risks: Over-reliance on critical customers or products, dependencies in supply chain risks.
• Financial Risks: Exposure to interest rate risks, fluctuations in revenue, exposure to currencies.
• Management Risks: Excessive top team change or lack of management experience.
• Litigations: Pending or impending litigation which is likely to impact business operations.

Knowing these risk factors, you can make a decision on whether or not the investment would be for your risk profile.

4.How to calculate ipo valuation?

The second highly crucial aspect of an IPO analysis is how valuation is presented. It helps identify if the share price is justified in comparison to the company's earnings and prospects within the marketplace. Major factor of valuation:

• Price-to-Earnings (P/E) Ratio: Compares offer price to the firm's earnings. Compare with listed equivalents of the same industry.
• Price-to-Book (P/B) Ratio: Compares market price and book value of assets.
• Enterprise Value to EBITDA (EV/EBITDA): A measure of whether the company is under or overvalued.

If the IPO is priced substantially higher than its peer group without any reasonable justification, then this may be an investment you do not want to make. Verification of valuation will keep you from paying through-the-roof prices for the IPO's shares.

5. Promoter and Management Analysis

The business leadership of a firm is critical to its sustainability. Assess:

• Promoter Holding: The greater the post-IPO promoter holding, the healthier the business in the firm.
• Experience: Ensure that there is a spotless management track record and experience in the sector.
• Corporate Governance: Ensure disclosures regarding the board composition, independent directors, and transparency policies.

Ethical, good leadership is a good IPO to invest in.

How to Invest in IPO for Beginners?

Investing in an IPO for the beginners would seem intimidating. The following is a simple step-by-step guide to buy IPO:

• Open Trading and Demat Account: You would require both to invest in IPOs.
• Apply Using ASBA or UPI: Use net banking (ASBA) or UPI-based platforms like Paytm Money, Zerodha, etc.
• Choose Investor Category: Choose Retail Individual Investor (RII), High Net-worth Individual (HNI), or Qualified Institutional Buyer (QIB).
• View Allotment Status: Allotment cannot be guaranteed. Status can be seen online a few days after the IPO's closing.
• Listing and Trading: Shares will be credited to your Demat account and can be sold on listing date in case of allotment.

All this is now electronic and automatic, thus accessible to all.

Red Flags to Be Watched Out For

Not all IPOs are good ones. Watch out for the following red flags:

• Lack of Profitability: Offset losses with no discernible mechanism for profitability.
• High Debt: Increased leverage above industry average.
• Overvaluation: Overpriced IPO with no comparable fundamentals.
• Unclear Use of Proceeds: Proceeds used for debt retirement or promoter exit primarily, diluting the very reason for raising capital.
• Frequent Regulatory Problems: Prior history of compliance problems or fines.

Avoiding these IPO warning signs will protect you against losses.

Last Checklist Before Filing for an IPO

Before you invest in an IPO, utilize the convenient checklist:

• Do you understand the business model of the company?
• Is financial performance robust and consistent?
• Is valuation reasonable compared to peers?
• Are promoters good and experienced ones?
• Are risk factors of the IPO manageable?
• Is the fund application growth-oriented?

If answers to most of these questions are yes, then go for the IPO.

Conclusion

IPOs would be sound choices, especially for investment in established companies with potential for future growth. But uninformed IPO choices influenced by a bubble can be costly. Investors would be smarter and better decision-makers if they understood how to analyse IPO, read the IPO prospectus, separate IPO risk factors, and understand IPO valuation.
Invest your money and research prior to investing, and that makes long-term money and reduces the chance of loss. Sufficiently researched investment is always better than speculation purchasing.

For those looking to go a step further in planning their finances, platforms like Indiabulls Securities Limited can help. With their market insights, investment tools, and user-friendly platforms, managing your portfolio while being tax-efficient becomes a lot easier.

FAQs

1. IPO prospectus is what and where do I obtain it?

A prospectus of an IPO is a document which gives information on the company, finances, risk, and why a company issues an IPO. It can be found at SEBI website or stock exchanges' websites (NSE/BSE) under future IPOs.

2. How would I know if an IPO is overpriced?

One can also look for valuation multiples like P/E or EV/EBITDA and compare them with the peers listed in the same industry. If the IPO is pricing much higher with no better financials, then one would say it is overpriced.

3. Are small investors able to invest in IPOs safely?

Yes, small investors are able to invest in IPOs but one must research the company and understand the risks involved. Investing small amounts initially is a prudent approach.

4. Some of the most important IPO risk factors to watch out for.

The major risks include over-gearing, legal problems, weak finances, dependence on a narrow band of customers, and issues with the regulator. These are mentioned in the IPO prospectus.

5. Do all IPOs need to be invested in?

No. Not every IPO is an investment suggestion. Each firm must be researched separately on fundamentals, value, and market situation before making a decision.

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