Some of the IPO’s in the recent past have brought significant listing day gains for their investors i.e they have listed at a significant premium to their offer price.
This however, does not mean that all IPO’s are worth investing in. An overvalued IPO may list at a discount to their offer price and lead to significant capital erosion on the part of their Investors’.
It is therefore important not to jump at any or every Initial Public Offer that hits the market. While some IPO’s are worth investing in, others are not.
My Advice to you is: Do your research before you invest in a IPO.
This leads us to the question:
How do you decide whether an IPO is worth investing in?
To put it in other words, What are the factors that one should consider before investing in a IPO?
But, before we start, let us attempt to understand what an IPO is all about.
What is an IPO?
When a privately held company offers its shares for subscription to the public through the auspices of a stock exchange, the process is termed as an Initial Public Offer or IPO.
Factors to consider before Investing in an IPO.
As I had earlier mentioned, not all IPO’s are worth investing in as their offer price may be more than their intrinsic value. In other words, these IPO’s may be overvalued.
What then are the factors that you must consider before investing in an IPO?
In the following paragraphs I will attempt to underline the factors that will help you determine whether an IPO is worth investing in.
1. Performance and Growth over the years.
Consider what has been the performance of the company in terms of profitability as well as the ‘year on year’ growth in profitability registered by the company.
Also, consider whether the company has been able to register a growth in revenues over the years. Note that revenue growth is one of the most important factors to consider while determining whether an IPO is worth investing in.
Compare these numbers with industry data as well the performance of listed peers to see where the company actually stands.
2. Promoter’s Standing.
A promoter’s standing and experience are important factors to be considered while investing in an IPO. Consider how well other companies promoted by the same promoter-group are doing.
3. Post IPO Promoter Share Holding.
Consider what would be the post-IPO promoter shareholding in the company. A high promoter shareholding signifies the fact that the promoter have great confidence in the future growth and profitability of the company.
4. Objective of the Issue.
Consider what are the objectives of the current issue and how the proceeds from the issue is to be utilised by the company? Whether the company will utilise the proceeds to fund an expansion plan or merely repay existing debt, are issues to be considered in this regard.
Note that in case of an IPO there may be either a fresh issue of shares to the public or the existing shareholders may look to offload their stake to the public. Where there is no fresh issue of shares to the public and existing shareholders are merely selling their stake, the proceeds from the issue would not accrue to the company.
5. P/E Ratio.
P/E Ratio or the Price-Earning ratio is an effective tool to determine how attractively the issue price is valued.
P/E Ratio is simply the ratio between the Market Price of a share and its Earnings per Share (EPS).
For determining the P/E Ratio of the firm which has filed for an Initial Public Offer, the issue price should be used in place of Market Price as the numerator and the Post-Issue Adjusted EPS should be considered as the denominator.
The P/E ratio thus determined should be compared to the P/E Ratio of listed peer companies. Other things being equal, a lower P/E ratio (as compared to peers) would signify an attractive valuation. On the other hand, a higher P/E ratio could mean that the IPO is over-valued.
Note that P/E ratio should not be considered in isolation but combined with other meaningful data to arrive at your conclusion.
6. Post IPO Debt-Equity Ratio.
What would be the post listing Debt-Equity Ratio of the company. The debt-to-equity ratio shows the proportion of equity and debt that a firm uses in its capital structure. Debt always has a fixed interest obligation and a firm with high levels of debt may experience significant difficulty in meeting those fixed interest obligations specially during times of reduced profitability.
7. P/B Ratio.
The price-to-book ratio (P/B Ratio) is calculated by dividing the market price of the share by its latest ;book value per share’. Book value” represents a company’s assets minus its external liabilities (including preferred shared capital) and is referred to as Shareholder’s Equity.
Similar to P/E ratio, the P/B ratio thus determined should be compared to the P/B Ratio of listed peer companies. Other things being equal, a lower P/B ratio (as compared to peers) would signify an attractive valuation. A higher P/B ratio, on the other hand, could mean that the IPO is over-valued.
8. Outlook of the company.
Questions you can explore in this regard are:
What is the future outlook of the company? How well are they placed in terms of competition? What opportunities lie before the company and how well are they equipped to explore and take advantages of such opportunities? What immediate threats the company faces?
9. Future Outlook of the Industry.
Future outlook of the industry in which the company is operating is an important factor to consider while determining whether to invest in an IPO. A country’s demographic structure, its economic and political environment as well as its laws and regulations have a significant impact on the future outlook of any industry.
A firm may be managed by the best. But, if it operates within an industry where opportunities are limited, its growth can at best be moderate.
Source of Information:
Are you now wondering where you can find all these information. The company prospectus is one document where you will find most of the data and, this needs to be studied carefully. You can also refer to research reports published by brokerage houses. For industry related news you can always refer to industry journals and of-course there is the INTERNET. Just remember to cross-verify your information from multiple sources.
IPO’s can be attractive investment bets provided you do your research and invest right.
I encourage all of you to do your own research rather than blindly following your broker’s advice while investing in an IPO.
Thanks for your time and Happy Investing!