Investing in an IPO? Check for these 5 things first

In 2021, Indian companies raised more than Rs 27,000 crore through IPOs, while some companies that got listed in 2020 have seen a rise of more than 200% in their share price. Now, you might have seen a lot of big companies like LIC and PayTm get listed and it might have made you question whether to invest in one or not. But the stock market is all about timing your entry and exit correctly. Sometimes, the IPO is the right time to invest while sometimes, it is better to wait.

But when you decide to invest in an IPO, consider these 5 things: 

1. CHECK THE DRAFT RED HERRING PROSPECTUS

Every time a company wants to raise funds from the public by selling shares, it has to file a document called Draft Red Herring Prospectus, or DRHP, with the SEBI. The DRHP contains all details about the IPO that are essential for an investor to know before investing. It contains the company’s financial statements, the reasons behind the company's desire to raise money, how it will use it, what the auditor thinks of the company, etc. An IPO can be a completely fresh issue or a stake sale or a mix of both. Notice this: 

• If the DRHP says that IPO is a stake sale, it means that your money will be used to buy shares held by old investors. There is no increase in the number of shares issued by the company. 
• If the DRHP says that IPO will be a fresh issue, it means the company will issue new shares in the IPO. (So, when you check the balance sheet post the IPO, you will see more shares in the Share Capital part of the Financials.) 

2. HOW DO THEY PLAN TO USE YOUR MONEY?

If you loan your amount to a friend, would you not want to know how it’s going to be used? Similarly, it is very important to know how the company plans to use the IPO proceeds since it will affect your return on investment. For example:

• If the company raises funds to repay its debt, it will most likely not be a good short-term investment choice for an investor. When the company will reduce its debt, it will improve its financials but not really lead to production or revenue growth as such. This will not suit a short-term investor.   
• If the company plans to use the IPO funds to partly pay the debt, and the rest to expand the business or use it for general corporate purposes, then it indicates that the company will directly use an investor's money to grow. 

3. CHECK THE PROMOTERS AND THE MANAGEMENT

A few months ago, when the news broke that PayTm Founder Vijay Sharma was arrested and then bailed out for causing a road accident, PayTm shares tumbled down the drain. Even though this piece of news broke after he was out on bail.

An investor should closely check the company’s management and the promoters of the company since they hold the company together. The management and the promoters decide the company’s long-term and short-term goals and help execute them every day. The top management’s execution of its long-term plans impacts the working culture and also affects the share price of the company. 

4. UNDERSTAND THE BUSINESS

Knowing a company, the industry it operates in, the news around the company, and the future expectations from the company and the industry help investors make an informed decision about their investment. It helps investors identify new opportunities to invest in and indicates when to exit. Reading more about the company, its positioning, and its strategies impacts how much profits an investor can make. Check the assets, liabilities, sales growth, profitability, contingent liabilities, and tax issues. 

For example, in June 2022, investing in companies that make drones, green technology, and deal in renewable energy is recommended since these industries are just starting to develop and are bound to grow. 

5. YOUR REASON FOR INVESTING

An investor should know their reason for investing (and stick to it) since that affects their trading strategy. So, if an investor is investing in an IPO for quick profits on a listing day or for long-term purposes, that will affect their way of trading. 

• An investor wanting a short-term gain will be hooked to understanding the current market sentiments and will have to invest in companies that have extreme volatility.
• A Long-term investment person will place more importance on the fundamentals of the company and will invest on Day One and can forget about it since stocks are not so volatile.

What do you consider before investing in an IPO?