Tips to Choose a stock in an IPO for Investing: If you truly want to participate in an IPO but don’t have the idea of what to search for before investing? Don’t worry, in this article, we discuss the significant angles to keep an eye out before investing in a company. Here, we’ll talk about the vital things to look to choose an IPO for investing.
What is an IPO?
An IPO is a process through which a private or government own company can raise funds from the public through the primary market. And transforming itself into a public company whose shares are traded in a stock exchange (secondary market).
This is a favored method for raising funds as the company isn’t committed to paying interest as in the case of a loan, the company anyway is owned by the investors post the IPO. There can be various reasons why any company offer an IPO. Here are a couple of the reasons:
- For funding a new project or expansion plan of the company
- For carrying out new research and development works
- To fund capital expenditures
- To pay off the existing debts or reduce the debt burden
- For a new acquisition
- For the group of initial investors desiring to exit the company by selling their stakes to the public.
IPO Terms to Know Before Investing in an IPO
Following are some important terms that give imperative data for IPO investing. Understanding these terms are crucial to pick an IPO and make a good investment decision-
1. Size: The size generally means offer size. This is the total number of shares offered in the IPO multiplied by the cost per share. This shows the sum the company wants to raise from the IPO.
2. Price Band: This means the lower and upper limit of the share price within which the company will offer its shares to the public.
3. Fresh Issue: This means the new equity is issued to the public.
4. OFS: OFS (Offer for sale) means the distribution of existing promoters’ holdings which is given to the shareholders. Here no new shares are issued.
5. Opening/Closing Date: It is between these dates that investors are allowed to apply for the IPO.
6. Lot Size: In an IPO the total shares offered to the public are partitioned into lots. In an IPO the investors can not buy shares of any numbers. They need to do it in lots. Besides, minimum and maximum lot size is also mentioned.
For example. A Company is going public sets a lot size of 10 shares for each lot with a minimum and maximum lot purchase set at 1 and 20 respectively. This basically means that the minimum number of shares an investor can purchase is 10 and the maximum of 200. If an investor wants to buy shares in odd numbers (such that 96 or 102 or 112) he will not be able to do so.
7. Face Value: The face value refers to the original cost of the shares.
Tips to Choose an IPO for Investing – Things to look
Participating in an IPO is simply one more type of investment. The issue is that the organizations which go for IPO’s are generally new and there isn’t a ton of data accessible about them. In comparison, public companies have reports, organization news, and expert analysis accessible on the internet.
To keep away investors from falling to companies with weak financials, the administrative authority(SEBI) has made it obligatory for companies to give a Red Herring Prospectus (RHP). This outline is a summary of the company and gives important details like financial statements, income, profit, risk, etc of the company. You must read this Red Herring Prospectus carefully before investing.
Following are some important factors to check before investing in an IPO
— Promoter holdings
The prospectus includes data on whether the company is newly issuing shares or are they an offer for sale which are shares of existing promoters. According to the law, promoters are needed to keep a minimum holding of 20% after issue. But if the promoters are selling a significant segment of their holding this could be a warning. But, if the promoters choose to hold a huge portion of holding post the issue then it is an indication that they have confidence in the organization for future growth and want to be a part of it. Rather than utilizing the IPO as an exit opportunity.
— Allocation of funds raised through IPO
The prospectus also gives us data on what reason the fund raised through an IPO will be utilized. A good sign would be the company allotting the funds for future development. On the other hand, if the main reason for the IPO is only to take care of existing debt or obligations then these ought to be considered as warnings.
— Financial strength and growth Prospects
The value of the company relies intensely upon its growth rate to date and the prospective growth rate it can achieve in the future. The prospectus gives a history of its growth in different angles and annual reports. This will help you anticipate what the company may achieve in the coming years and it is worth investing in or not.
— Comparison with competitors
To evaluate the company’s performance, one should contrast the performance of the company with its peers /competitors in a similar industry. The IPO value also might be in contrast with different companies in a similar industry. Based on its performance and valuation compared with its peers, you can understand, the company is overvalued or worth investing in.
— Beware of the oversubscription trap
It is very important that Any type of investor needs to stick to their research and not on market reaction. Maximum time IPO’s are oversubscribed. As an investor, you should not get influenced by those data as subscriptions frequently follow the market trends. This implies that there are more chances of IPO’s being oversubscribed in the bullish market than in bearish.