Crucial Things to Know About IPO Investment

The primary market where new shares are offered to investors earlier saw a lull period. According to media reports, some more are expected to be announced over the next few months.

Here are five key things to know before investing in an IPO

What are IPOs:

Companies need money to operate. This can be sourced from bank loans and other borrowings or by raising capital through share issues. Each share represents a portion of the company. So, the company effectively sells a portion of its holding to raise money. So, you - the investor - then hold a right over the company and its profits. This issuance of shares happens in a separate section of the stock market called primary market. Once the shares are issued to investors, they get listed on the secondary market, where they are traded on a daily basis. A company many issue thousands of shares at one time. For each such share, investors pay a certain amount. The total amount a company gets for its shares is the 'capital' raised. This money is then used for operating the business. This process is called as listing or 'going public'.

Dig Deep for Objective Research

Conducting in-depth research is a fundamental step in how to invest in an IPO. Start by gathering information about the company, its business model, financial health, and market position. Look for unbiased sources that provide a comprehensive analysis of the company's prospects. It's important to differentiate between the hype surrounding an IPO and the actual potential of the company.

One effective way to gather objective research is by examining the company's financial statements, historical performance, and growth projections. Pay close attention to the company's revenue, profit margins, and debt levels. This data will help you assess the company's financial stability and growth potential. Additionally, consider the competitive landscape and the company's position within its industry. Understanding the market dynamics and the company's competitive advantages will provide valuable insights into its long-term prospects.

How To Invest:

There are two types of IPOs depending on the price of the shares - fixed price and book building issue. In the former, as its name suggests, the company fixes the price of shares in advance. No investor can get the shares for a rate higher or lower than this amount. In the book building issue, however, you have to bid for shares. The company will give you a range of prices. You have to bid within this range. Depending on the bids, the company will then allot shares to investors. This process - called Book Building - takes 15 days. To do so, you have to place money in your IPO trading account and then order. You have to do this before the IPO closing date. If your bids are successful, you will receive a Confirmatory Allotment Note (CAN) on the settlement date. If you fail to get any shares in the issue, your money will be refunded within 15 days.

Pick a Company with a Strong Broker

Selecting a company with a reputable and strong broker is another crucial aspect of IPO investment strategy. A strong broker can provide valuable insights, guidance, and support throughout the investment process. They have access to extensive research, market analysis, and industry expertise that can help you make informed decisions.

When choosing a broker, consider their track record and reputation in the market. Look for brokers with a history of successful IPO placements and positive client feedback. A reputable broker will have a deep understanding of the IPO market and can provide you with comprehensive information about the company's prospects, risks, and potential returns.

Additionally, a strong broker can offer access to pre-IPO shares through private placements or preferential allotments. This early access can be advantageous, as it allows you to invest in the company before its shares become available to the general public. However, it's important to carefully evaluate the terms and conditions of such investments and ensure they align with your investment goals and risk tolerance. Working with a strong broker also provides the benefit of professional advice and support. They can help you navigate the complexities of the IPO process, including the application, allotment, and trading of shares. Their expertise can be invaluable in maximizing your returns and minimizing potential risks associated with IPO investments.

Advantages:

The stock market is all about betting on the future growth potential of the company. The sooner you buy shares of good company, the better. This will help you take advantage of a higher rise in share price. An IPO allows you to be one of the first investors to unlock the company's potential. This means, you effectively get to buy shares at cheaper rates. For example, Infosys shares got listed at ₹95 in June 1993 (but adjusted for bonus and splits, the original IPO cost of these shares works out to 48 paise). Today, these very shares are worth over ₹2,000 apiece. So, if you had invested in the Infosys IPO, your shares' value would have jumped over 4000x (a staggering 458233% increase). Secondly, 35% of the share offering is reserved for retail investors. As part of this reservation, retail investors can bid for shares worth up to ₹2 lakh. This means, you have a good chance of getting shares allotted in every IPO, even the unsubscribed ones.

Always Read the Prospectus

A critical step in how to buy an IPO is thoroughly reading the prospectus. The prospectus is a legal document that provides detailed information about the company's operations, financials, and the specifics of the IPO. It is designed to help potential investors make informed decisions by offering a comprehensive overview of the investment opportunity.

The prospectus includes key information such as the company's business model, revenue sources, risk factors, and use of the proceeds from the IPO. It also contains details about the company's management team, their experience, and their vision for the company's future. By carefully reviewing this document, you can gain a deeper understanding of the company's operations and its potential for growth. Pay special attention to the risk factors section of the prospectus. This section outlines the various risks associated with investing in the company, including market risks, operational risks, and financial risks. Understanding these risks is crucial for assessing the potential downside of the investment and making an informed decision.

Another important aspect to consider in the prospectus is the valuation of the company. Evaluate the pricing of the shares and compare it with the company's financial performance and growth prospects. Assess whether the valuation is reasonable and aligns with your investment expectations. Overvalued IPOs can pose a risk, as they may be more susceptible to price corrections in the market.

Take note of any lock-up periods mentioned in the prospectus. Lock-up periods are restrictions that prevent insiders and early investors from selling their shares for a certain period after the IPO. Understanding these restrictions can help you anticipate potential fluctuations in the stock price once the lock-up period expires.

Risks:

IPOs are usually issued by new companies, which are not yet established or growing at a steady path. The risk involved is thus higher. You are essentially betting on the company's growth prospects. If the company fails to take off as promised after the IPO issue, its shares may tank and you may lose your money. Secondly, unlisted companies do not have to publish financial performance every quarter. This means, it will be more difficult to track the company's past performance before listing. However, a company that applies for listing has to provide records of its past financial performance. These will be part of the company's prospectus.

Things To Remember:

Always ensure you read the company's prospectus clearly. This will mention all details of the IPO - the company, its finances, the amount of money it expects to raise, the type of shares that will be issued, the number of shares on offer and so on. This is the only way to know about the company's financial performance. Never invest blindly in an IPO.

Consider Waiting for the Lock-Up Period to End

One strategic approach to IPO investment is considering waiting for the lock-up period to end before investing. The lock-up period is a specified duration during which insiders, such as company executives and early investors, are restricted from selling their shares. This period typically lasts for 90 to 180 days after the IPO. Waiting for the lock-up period to end can provide several advantages. Firstly, it allows you to observe the company's performance and stock price movements without the initial volatility often associated with IPOs. The expiration of the lock-up period can lead to increased selling pressure as insiders may choose to sell their shares, potentially causing a temporary dip in the stock price.

By waiting for this period to pass, you can gain a clearer picture of the company's market performance and investor sentiment. It also allows you to make a more informed decision based on the company's post-IPO financial results and any significant developments. Additionally, you can assess how the company is being received by the broader market and whether it is meeting its growth projections.

The Bottomline

Before diving headfirst into IPO investment, it is always prudent to conduct due diligence to ensure that the investments align with your financial objectives. By being mindful of the important aspects listed above, you can devise an effective strategy that is complemented by IPO investments.

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