IPO is short form for Initial Public Offerings. IPO generally creates lots of curiosity among retail investors as well as big institutions around its listing time. IPO gives an opportunity to investors to invest in a company during its transition from Private to Public ownership. Investment in securities market always comes with the probability of risks and same applies with the investment in IPO’s. This article will provide you insights on the several key factors to consider while deciding to invest in IPO.
1. What is an IPO?
IPO is the platform through which a private company offers shares of its company for investment to the public for very first time to raise capital. Capital raised is usually used to expand operations, pay off debt, and to invest in new projects. It is an opportunity to invest in a company at an initial stage of its public journey.
2. Why IPOs Are Attractive?
IPOs can be enticing for several reasons:
- Opportunity for High Returns: Many IPO’s have given fantastic returns on investment in short span of time, like for ex. Avenue Supermarkets.
- Early Entry Opportunity: Investing in IPO’s gives one an opportunity to buy a stock at its initial stage and can take maximum benefits from its returns.
- Company Growth Prospects: Generally IPO’s are being introduced by those companies who are in growth phase and thus it means it could provide higher valuations in future.
3. Risks Associated with IPOs
Though IPO’s have great potential for good returns, it also comes with risks:
- Volatility: During its initial days from listing, IPO’s face significant amount of volatility in trading.
- Limited Information: Since it is recently listed, unlike other listed companies, IPO companies have less data available for analysis.
- Lock-in Periods: There are several IPO’s who are listed with per-defined lock-in periods thus making it difficult for early investors as well as insiders to sell their shares immediately after listing. Also there maybe significant drop in price of shares once the early investors and insiders start selling their shares.
4. Factors to Consider Before Investing in an IPO
a. Company Research:
Proper research regarding company’s fundamentals is important before investing in an IPO:
- Understanding the Business Model: Understanding the business of a company you are investing it through IPO is very important. There are instances where the company’s business model looks very promising on papers but it disappoints in real world.
- Analysis of its Financial Performance: Go through company’s past performances, its revenue, profitability, and debt levels.
- Growth Potential: Check whether there is sufficient room for growth in the sector in which company operates.
b. Evaluate the IPO Pricing:
- Fair Value: Any price set by the company above its fair value may result in poor returns. Hence Evaluate the company’s valuation with its competitors.
- Under-pricing Risks: Generally, it is considered that an under priced IPO can provide good returns in short time but this may also show that the company is low in confidence in its value.
c. Check the Promoters and Management:
Always check the company’s promoters and its management as they are the ones whose performance will decide the future of that company.
- Track Record: Check in detail regarding the company’s founders, promoters as well those in the management.
- Skin in the Game: Make sure promoters have a significant holding in the company which indicates their Long-Term commitment to the company.
d. Understand the Purpose of the IPO:
Why is the company going public?
- Debt Repayment: Check if the amount received through IPO will be primarily used for paying off the debts, this could signal in financial instability.
- Growth and Expansion: The company which utilizes this fund for innovation or market expansion are more attractive.
e. Assess Market Sentiment:
Check broader market conditions:
- Bullish Markets: IPO’s listed during strong market scenario gives better returns due to higher demands.
- Economic Factors: Keep a watch on macroeconomic conditions like Interest rates and inflation.
f. Review Lock-in periods and Insider Activity
Understand the restrictions on insider trading:
- Lock-in Period: The share price may be stable during the lock-in period but it could trigger a sell off once the lock-in period is ended.
- Promoters confidence: Promoters selling stock immediately after lock-in period may indicate lack of confidence in the company’s long term growth.
5. Questions to Ask Yourself Before Investing
a. What is the reason for Investing in IPO?
- Is your investment purpose Long-term growth or short-term growth?
- One’s risk appetite that comes with IPO volatility?
- Investing in IPO may prove to be very difficult for the conservative investor due to its unpredictability.
b. Do You Understand the Company and Its Industry?
Make sure that one has proper knowledge or seek advice before Investing in an IPO. As any investment without proper knowledge and understanding of the company may prove to be very risky.
6. Alternatives to IPO Investments
There are many other ways for Investment if One is unsure regarding directly investing in an IPO:
- Wait and Watch: Let the newly listed stock stabilize post IPO and one can assess its performance and then invest.
- Mutual Funds and ETFs: There are some Mutual Funds who invest in IPO and thus it reduces the risk exposure.
7. Conclusion
Investing in an IPO is like double edged sword, you may get good returns in some and you may loss your capital in some. Careful analysis is must before Investing in IPO and to get the clear understanding of the associated risks. One can make a sound decision by going through the company’s fundamentals, pricing, management, and other broader market conditions.
Please Note, IPOs are not a guaranteed path to riches. They should meet your financial goals, your risk tolerance, and your investment strategy. It is always advisable to seek professional expertise to make sure the decision fits your overall financial plan.
Do not rush in any investment, research thoroughly and invest wisely!
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