6 Tips for Investing In IPO

  •  5 min read
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  • 27 Dec 2023
6 Tips for Investing In IPO

Key Highlights

  • Companies seek an initial public offering (IPO) when they choose to transition from private to public ownership.
  • An initial public offering is intended to raise and distribute funds from the general public. Investing in initial public offerings can be an attractive option for investors.
  • However, investors are making a series of mistakes that reduce their overall returns.

IPO is a term used for an initial public offering. The initial public offering can be defined as the process by which a private company or enterprise sells part of its equity to investors in order to become publicly listed. In general, the initial public offering aims at injecting new equity capital into the company to facilitate easy disposal of existing assets, raise funds for the future or monetize investments made by current shareholders.

Details of the first share sale are accessible to institutional investors, high-net-worth individuals, and the general public in the prospectus. The prospectus contains an extensive list of the information to be included in the offer. When the initial public offering is completed, its shares will be made available for trading in the market free of charge. The exchange requires a maximum free float of shares to be fixed in the actual value and as a share capital ratio.

The market waits for the first share price performance on the markets when such initial public offerings are launched. Due to the common belief that stock prices will rise when a company goes public, most investors rush to apply for an initial public offering.

It is an excellent opportunity to book profits quickly. Nevertheless, when you are investing in initial public offerings, particularly for new investors, certain crucial factors need to be taken into account. Some of the main points are given here.

1. Study company profile An investor needs to ensure that the corporate profile is checked to assess its capabilities over time before taking part in an initial public offering. Understanding its overall growth potential can benefit from a look at the company's financial history. This information allows an investor to judge the exact reason why a company is likely to undertake an Initial Public Offering and where it intends to use funds raised from that offering.

2. Know what the investment objective is. It might be counter to one's expectations to invest in an initial public offering with only the aim of achieving listing gains. Investors should be aware of their risk profile and weigh these decisions, taking into account investment objectives, particularly those who have already started to invest in stocks. It is advisable to choose a long-term gains perspective rather than a short-term listing gains perspective when choosing the appropriate investment, be it an IPO or another option.

3. Beware of oversubscription The company may offer a restricted number of shares in the initial public offering. A decision is usually taken as to which categories of investors will be allocated shares. Sometimes, the total number of applications for an Initial Public Offering may be much higher than the number of shares that are offered. However, a proportionate allocation of shares is made to all applicants. Therefore, the investor may receive fewer shares than he applies for.

4. Evaluations of the company's value Another key factor that investors need to consider when investing in an Initial Public Offering is the valuation of a company. Comparisons between the company's price-to-net income ratio and returns on equity against its competitors are the most suitable way of doing this.

The price-to-earnings ratio is the share price of the company's earnings per share. Return on equity = net income/shareholder’s equity.

The assessment of the financial health and capacity to grow can be facilitated by analyzing a company's financial data. For instance, in order to evaluate the level of leverage applied, an investor may look at a company's debt and equity ratio.

5. Following the hype v/s independent investment decision When making an investment decision, it's important to be objective. Suppose the current stock market situation turns negative, for instance. In that case, this is going to raise speculation on Initial Public Offerings, which may need to be more successful in the near term. But if its fundamentals are strong, it could be in a better position for the future. Therefore, when making investment decisions in initial public offerings, investors need to avoid becoming distracted by market speculation.

Read the fine print through the company prospectus. The prospectus of the company shall contain information concerning its activities, capital structure, financial statements, management opinions, and so on. The prospectus provides investors with an overview of the entire IPO but also gives them a view into its details. In order to be better prepared for the investment decision, this information can assist you in doing so.

Conclusion

Invest only in initial public offerings if they are compatible with your risk appetite and financial objectives. In order to assess the public response, many experienced investors invest in initial public offerings on the second or third day after their opening. There is a higher chance of listing gains when the issue is oversubscribed. In the end, an informed investment decision, as opposed to following the usual market frenzy with regard to an initial public offering, can yield positive returns.

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