The retail-side investors are interested in IPOs, which they consider significant opportunities in the capital market. An IPO is simply the first time a public company sells a private placement of shares to the public. Investments in IPOs sometimes include exposure to new business models, sectors, or companies. However, the investor should conduct the necessary due diligence to ensure that an IPO is worth his risk and capital.
Why do Retail Investors Prefer Going for IPOs?
Opening an IPO for retail-level investors resembles entering a stock at an early stage of its market availability. IPOs can be included in existing portfolios as a way of diversification by introducing companies from newer sectors or industries. Investors must observe the offer carefully and look into its particulars rather than rely solely on hype and on expectations for quick returns to come.
Tips for Retail Investors: How to Analyze IPOs Before Investing?
- Analyse the Draft Red Herring Prospectus (DRHP)
In the DRHP, first are the essential IPO documents filed with the regulatory authority. Information about the company, its financials, risk factors, objectives of the issue, and details about promoters is some of the important information provided by it. Reading the DRHP will help the investor to understand how the company is structured and what its purpose is concerning raising capital.
- Assess Financial Performance
Investors should analyze the last three to five years regarding their financial standing (as highlighted in the DRHP), covering parameters like
Revenue and profit trends
EBITDA margins
Return on equity (RoE)
Debt-equity ratio
Cash flow from operating activities
Numbers for these parameters that are stable and showing growth indicate that the business is performing reasonably well.
- Verify and Understand the Company’s Business Model
Investors need to analyze the company’s revenue streams. Namely, the products and services that it provides to the market and targeted customers. Niche companies face different risks and rewards than those operating multiple products. The understanding of business models must also include specific reference to dependencies on customers, geographies, or suppliers.
- Investigate Promoters and Management
Past behavior of the promoters and their core team indicates the quality of leadership and operational efficiency. For this reason, the investors need to assess the promoters’ prior business ventures and experience in the sector, as well as check for any legal or regulatory issues involving them.
- Research Industry and Competitive Landscape
Investors should compare the company going public with its listed peers to assess the market position of a company associated with an IPO. Such analysis will be centered around:
Share of business
Competitive advantages
Strengths and weaknesses pertinent to the sector
Regulatory environment
- Go through Valuation Metrics
Investors need to assess the expected IPO price in comparison to the valuation multiples of peers in the industry.
- List Down Risk Factors
An IPO carries certain risks—operational and regulatory—depending on the stability of that specific sector. The DRHP provides for an in-depth elucidation of these risks. Investors, therefore, should read this section carefully and ascertain their comfort level vis-à-vis these risks for investments.
- Use IPO App to Get Latest Updates
An IPO listing app will be a handy tool for tracking newly opened and upcoming IPOs. These IPO apps provide operating financials, analytical reports, subscription status, and allotment dates for the company. Investors can set alerts to track listing performances post-IPO. Some popular apps offer simplified summaries of DRHPs, which could serve retail investors looking for quick insights.
- Check Confirmation of Use of Funds
The offer document commonly states the intended uses for which proceeds from the public offering are designed. Typical objectives include:
Capital expenditure
Debt repayment
Support for working capital
General corporates
- Stay Clear of Grey Market Premium (GMP)
GMP is a price that represents the market price of IPO shares before the shares are listed for trading in the stock exchange. GMP may represent market sentiment, but it can never be considered correct. GMPs vary in value, are subject to speculation, and are not directly correlated to actual fundamentals.
Final Thoughts
Investors’ understanding of how to analyze IPOs before investing entails a wider analysis of the company’s relevant fundamentals, industry context, quality of management, and valuation. Meanwhile, IPOs can create opportunities, but IPOs also bear related risks concerning the market and companies.
