An Initial Public Offering (IPO) is when a private company offers its shares to the public for the first time. It gives people a chance to buy shares before or at the time of a company’s stock market debut. However, not every IPO is a good investment. Some companies have strong business plans and healthy finances, while others may have high debt, weak profits or expensive share prices.
Before you apply for an IPO, it is important to study the company and understand its value. A little research can help you make a better choice and reduce the risk of loss.
Understand the Company’s Business
The first step is to understand what the company does and how it earns money. Read about its products, services, customers and main sources of income. Also, check which industry it belongs to and whether that sector has good growth prospects.
Try to understand what makes the company different from its competitors. It could have a trusted brand, a strong customer base, better products or a wider market reach.
You should be able to explain the company’s business in simple words. If its business model is too hard to understand, take more time to study it before you invest.
Check the Company’s Financial Health
A company’s financial records can tell you a lot about its performance. Before you apply, check its financial results for at least the last three years.
Start with revenue, which shows how much money the company earns from its main business. Check whether its revenue has grown over time. Next, look at net profit to see whether the company earns more than it spends.
You should also check EBITDA, which gives an idea of the company’s core business performance. Debt is another important factor. A company with too much debt may face trouble if its income falls.
Cash flow also matters. A company may report a profit but still have trouble with cash. Check whether it earns enough cash from its main business.
Two other useful measures are Return on Equity (ROE) and Return on Capital Employed (ROCE). ROE shows how well the company uses shareholder money, while ROCE shows how well it uses its total capital.
A company with steady revenue growth, healthy profits, low debt and positive operating cash flow may have a stronger financial base.
Check Whether the IPO Price Is Fair
A good company may still be a poor investment if its shares cost too much. This is why you must check the IPO valuation before you apply.
The Price-to-Earnings (P/E) ratio compares the share price with the company’s earnings per share. The Price-to-Book (P/B) ratio compares its market value with its book value. The Price-to-Sales (P/S) ratio compares its market value with its revenue. EV/EBITDA compares the company’s total business value with its operating earnings.
Do not study these ratios alone. Compare them with those of other listed companies in the same industry.
For example, if similar companies have a P/E ratio of 25 and the IPO company has a P/E ratio of 60, its shares may be expensive. However, a higher price may have a reason if the company has better growth prospects. Study the facts before you decide.
Study the Promoters and Management
The people who run a company have a major role in its success. These people include the promoters and senior management team.
Check their work history, business experience and past records. Find out whether they have managed other businesses well. Also, check for legal cases, regulatory action or serious corporate governance issues.
Pay attention to related-party deals. These are business deals between the company and people or firms linked to its promoters or management. Such deals are not always wrong, but they should be fair and clear.
A company with honest and capable leaders is often in a better position to build trust and support long-term growth.
Understand Why the Company Wants to Raise Money
Before you apply, find out why the company plans to raise money through its IPO. There are two main parts of an IPO: Fresh Issue and Offer for Sale (OFS).
In a Fresh Issue, the company creates new shares and receives the money from their sale. It may use these funds for business growth, debt repayment, new projects or capital expenses.
In an OFS, existing shareholders sell some of their shares to the public. The money goes to those shareholders, not to the company.
A large OFS is not always a bad sign. However, you should understand why the existing shareholders want to sell their shares and whether the company itself will receive enough funds for its future plans.
Read the Risk Factors
Every IPO has some risks, and you should know about them before you invest. The Red Herring Prospectus (RHP) has a section that explains the main risks linked to the company.
Check whether the company depends on a small number of customers or suppliers. Such dependence can affect its business if a major customer leaves or a supplier stops its service.
Also, look for high debt, pending court cases, falling profit margins, tough market competition and changes in government rules. A company may also depend too much on its promoters or a few key employees.
Read these details with care. Do not ignore a risk just because the IPO has a lot of public attention.
Check IPO Subscription Numbers
IPO subscription data shows how much demand the issue receives from different types of investors. There are three main groups: Qualified Institutional Buyers (QIB), Non-Institutional Investors (NII or HNI) and retail investors.
QIBs include large financial institutions and other eligible investors. NII or HNI investors apply for shares above the retail limit. Retail investors are individual applicants who apply within the set limit.
High subscription may show strong market demand, but it does not promise a profit. A popular IPO can still list below its issue price.
Understand the Grey Market Premium
Grey Market Premium (GMP) is the extra amount at which IPO shares are said to trade in the unofficial market before their stock market debut.
For example, if the IPO price is ₹100 and its GMP is ₹30, the expected unofficial price is ₹130.
However, GMP is not an official market figure. It is based on unofficial deals and can change at any time. It does not promise the same price on the listing day. Never apply for an IPO based only on its GMP.
Review the Company’s Future Plans
Check what the company plans to do after the IPO. It may want to expand its business, launch new products, enter new markets, increase production, repay debt or spend more on research and development.
These plans should match its financial position and business goals. A clear plan with realistic targets can support future growth. Be careful if the company makes big promises without enough facts to support them.
Make Your Final Decision
Before you apply, take a final look at the company’s business, financial health, share price, management, IPO purpose and major risks. Also, make sure the investment suits your financial goals and risk level.
Do not make a decision just because an IPO has high subscription numbers or a strong GMP. These details may show market interest, but they do not tell the full story.
Final Thoughts
An IPO can offer a good chance to invest in a company at an early stage of its life on the stock market. However, it also comes with risks. The best way to make a sound choice is to study the facts rather than follow market hype.
Focus on three main things: the quality of the business, its financial health and the price of its shares. Most importantly, read the RHP before you apply. It has useful details about the company, its promoters, financial records, risks and the purpose of the IPO.
A strong company at a very high price may not be a good investment. Always understand what you are buying and why you want to invest before you make your final decision.
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