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5 things to keep in mind before investing in an IPO
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An IPO or Initial Public Offering is the process through which a company first issues its shares to the public. IPOs are launched in the primary market and when a fundamentally strong company goes public, investors flock to bid for its shares in the initial offering. They may enjoy listing gains, which are the profits generated when the company’s shares are listed on the stock exchange. In addition to this, if and when the company’s shares appreciate over time, investors also stand to benefit from the capital gains.
That said, if you’ve had an upcoming IPO on your radar, there are some important things to keep in mind before you invest. Check them out below.
1. Read the Red Herring Prospectus
The Red Herring Prospectus (RHP) is an official document that companies must file with the Securities and Exchange Board of India (SEBI). It contains all the key details about the company’s IPO, its financial statements, its future prospects and details about the management among other things.
These are essential details that you need to gain a better understanding of the offering before you invest in the company. You can find the RHP of a company online and it’s typically available free of cost.
2. Check the reasons for the IPO
There are different reasons why a company may opt for an IPO. Some companies may need the funds for business expansion and growth. Others may need the funds to settle their existing liabilities. And yet others may initiate an IPO to give their promoters a means of exiting their shareholdings.
Not all reasons may be beneficial from the investor’s point of view. Typically, if a company plans to raise funds via an IPO to settle its debts, that’s a red flag you need to make a note of. On the other hand, if the IPO is primarily to drive the growth of the business, it may be a good sign for investors.
3. Evaluate the company’s strengths and weaknesses
Every company has its own strengths and weaknesses. Before investing in the IPO of a company, it’s best to evaluate what its potential strong points and vulnerabilities are. A SWOT analysis is the best way to go about this. You can identify the strengths and weaknesses from the Red Herring Prospectus itself. You can also check out analysts’ reports, go through the news and see where the company stands in each of the quadrants.
You can look at its future prospects too, so you get a better idea of how the company may grow in the coming years. This will give you clarity on whether or not the stock has long-term growth potential.
4. Perform a quick valuation of the company
Valuation is an essential aspect of evaluating an IPO. A company may be overvalued or undervalued. If the IPO price is much higher than the intrinsic value of the company’s shares, the company is said to be overvalued. This means that in case of a price correction at a later date, the company’s stock price may fall.
On the other hand, if a company’s IPO price is lower than the intrinsic value of its shares, the company is said to be undervalued. This could indicate a potential for future growth, when the price corrects itself to align with the company’s true value.
5. Check the company’s performance against its peers
Lastly, you also need to be aware of how the company compares with its peers. Is the company’s performance in tune with the industry average? Is it better, or is it worse? These details will give you a better idea of whether or not an IPO is worth investing in. You can make use of financial metrics like the price to earnings ratio, debt to equity ratio, profit margins, earnings per share and the return on equity ratio, among others.
Conclusion
Being mindful of these principles and pointers can help you make an informed decision about investing in an IPO. And once you’ve purchased the shares, ensure that you have a good exit strategy. You need to be clear about whether you plan to hold the stocks over the short term, or if they are long-term investments instead. This will help you monitor your portfolio as needed.
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