Initial public offer: What’s your objective of investing in IPOs?

By Harjit Singh

In the past few months, a large number of corporate houses have submitted proposals for floating initial public offering (IPO). Besides this, a number of IPOs are expected to hit the market soon. As companies line up to raise funds from the market amidst high valuations, investors need to consider numerous factors before investing their money in an IPO.

Consider investment goals
Before investing in an IPO, you need to ask yourself some questions to ascertain what sort of strategy you should consider. The reason is an investor cannot always decide on what sort of investment decision is right for him unless he is clear about his investment goals. In addition, a number of your choices can only be judged based on your present investment portfolio.

For instance, if investors are heavily invested in the large-cap stocks, investing in an IPO from a large enterprise may make their portfolio even more uneven. On the contrary, investing in an IPO propelled by a small or mid-cap company may help bring some balance to the portfolio.

Investment horizon
Look at your investment horizon. What is your objective of entering into an IPO market? Would you like to snatch a quick profit? Or want to hold shares for a longer period? This eventually will decide your IPO strategy. A short-term investment strategy heavily depends on prevailing market sentiments while a long-term disposition will force you to consider the fundamentals of the company.

Question yourself
As IPO investing is a high-risk high-return game, you need to question the justification of investing. Here are some important questions that an investor must think about before investing.

n Will you be ready to own the stock if the prices fall by 40-50%? The response to this query will throw light on your real investment goals.
n What percentage of your portfolio would be allocated to IPO investment and what is your risk tolerance? Investing in an IPO is entirely different from investing in listed companies and this question will demonstrate your risk appetite.

n Are you planning to invest in an IPO to ‘flip’ (short-term strategy) it or have plans for staying long term? This question is focused to make your journey straight. The answer to the question may change the type of IPO you are choosing and your points of consideration may alter as well.

Golden rules of investing in IPO
Making money in an IPO is not as easy as it seems. Though you have decided your investment goals and the appropriate strategy to achieve them, you still need to select the right kind of IPO. There are multiple rules that can assist you ascertain the right issue. Prominent among them are: –

DRHP: Securities and Exchange Board of India (Sebi) has made it mandatory for the companies going public to submit ‘draft red herring prospectus’ (DRHP) to it. This document serves as a rich source of information that may change investors’ decision, if they seriously go through it. For instance, the prospectus highlights the current share distribution pattern. A higher percentage of shares held by banks and institutional investors is a positive sign, signifying their confidence in the performance of the firm. One can also know about the management team, company’s future plans, and their qualifications.

Promoters’ profile: One of the important rules is to know the entity that is promoting the IPO. Well-established names, organisations add credibility and add a premium to the float price.

Grading: The grading of an IPO also plays a vital role in the IPO market. Higher the grading, better are the chances of the IPO being a success. However, this is not conclusive as companies with outstanding grades have had to pull out their IPOs.

Invest in the business you understand
Never invest in a stock. Invest in a business instead. And invest in a business that you understand well, otherwise never invest. Renowned investor Warren Buffett always says: “Invest within your sphere of competence.” The reason behind this philosophy is that a deep understanding of a business can help you make wise decisions.

Last but not the least, listen to all but do your own SWOT analysis instead of mere hearsay. Selecting the best IPO is not so difficult if you know what to look for. Plan your finances wisely and don’t put all your eggs in the same basket. Diversify it.

The writer is associate professor, Amity School of Business, Amity University