A range of factors informs the value of stocks – from the basic rules of demand and supply to results of fundamental analyses and macroeconomic determinants. For stocks already trading in the market as well as additional issues made by a company, the same rules apply. An analysis of these factors is used by investors to buy or sell their shares based on the principles of valuation trading.
The performance of new companies going for initial public offering (IPO) can be challenging to analyse. For this reason, the value of shares going for IPO is difficult to evaluate. Then, how to apply for an IPO? Fundamental analysis is out of the question. This lack of a point of reference makes some traders and investors skeptical, while others look at it as an opportunity to buy.
What to look for?
So, how does one ascertain whether a particular company’s shares are worth investing in? The approach to analysing IPO differs vastly from the one taken to study other types of issue. Here’s what you should look for when considering investment in an IPO:
Purchasing oversubscribed shares that have just been introduced into the market – thanks to IPO – can be a great way to make profits for traders. To be able to access these, you must have a good relationship with your broker so that you may receive these shares before anyone else does. The value of oversubscribed shares will continue to rise as they become available for customers in the open market. This happens because the demand and supply for such shares take some time to equalise.
Why has the company gone public?
When a new company launches its IPO, there is often considerable reason to cheer. However, it is wise for investors to research the reason why the firm has chosen to resort to IPO in order to raise capital. Or ask the question – what does the company wish to do with the funds raised through IPO? It could be for purposes of expanding its business, paying off debt or meeting requirements of working capital.
So, then, in which scenario is it prudent to invest? If a company wishes to expand its operations or meet its debt obligations, it can be a good idea to invest in it because the IPO would give a fillip to its future profitability and revenue. However, on the other hand, if the company plans to divert IPO funds into its working capital, investors should be wary of putting their money into it.
Even though a company’s past record on the stock market does not exist, investors can dig into its previous credentials to get a pulse of its financial performance. While understanding how to analyse IPO, you must make sure to check for trends in profit and revenue and see if they have been dipping or rising over the past three years. If its profitability has been increasing, it can safely be considered a good investment. However, falling revenues over the past few years are a warning sign and traders should steer clear of such investments.
Ratings given to the company by credit rating agencies such as India Ratings, CRISIL and CARE can reveal a lot about a company. They provide investment grades for companies preparing to go for IPO. Companies that are faring well financially will usually receive a rating of 4 or 5.
Traders can make an educated speculation of the future performance of a company based on a number of factors. They must watch out for the company’s industry peers and competitors and evaluate how the firm in question fares when compared to their services and products. Its growth prospects can also be ascertained from its admission, if available, of the profitability it aims to achieve.
Moreover, the quality of its leadership and the existence of legal issues should also be taken into consideration before making any decision. Finally, and most importantly, investors should understand the company’s business model and whether or not it will be able to sustain itself in the future and against its competition.
Valuation based on metrics:
It is imperative for traders to know whether the shares being offered in an upcoming IPO are overvalued, fairly valued or undervalued. Traders should consider the firm’s price-to-book-value, price-to-earnings, debt-to-equity and other ratios when compared to its competitors. Shares that are overpriced compared to their peers should not be invested in.
How to Analyse IPOs
An IPO consists of fresh issues and offer for sale (OFS). Fresh issue refers to the capital used by the company to run its business operations, and OFS is the sale of a promoter or private investor’s stake in the company.
Now, if an OFS being offered is bigger than the fresh issue, it signals that the company’s promoters are selling their stake, which is usually a bad sign for investors. On the other hand, if the OFS is lower than the fresh issue, it shows that the company’s growth prospects are good.
When analysing a company’s fresh issue in the IPO, the objective for the capital thus raised should be kept in mind. If it is being raised for repayment of debt, or to solve its working capital and cash management issues, investors should understand this could be a red flag. But if the funds will be used for mergers and acquisitions, it is a good sign.
Offer for sale:
If the OFS is being made by a promoter of the company, investors should understand the reason behind such a move. Has the promoter pledged their shares, or owns other businesses into which funds can be diverted? If yes, then such an investment could be detrimental for you. If a private equity investor has made an offer for sale, remember to check if it stems from a lack of belief in the company’s future growth.
Signing up for IPO can be intimidating since little prior knowledge of the company in question seems to be available. However, based on their style of trading and investment goals, people can invest in IPO. Traders who seek to make profits without holding on to the stocks for too long can gauge the initial uncertainties around valuation to make a quick buck. However, the true nature of the company’s fundamentals and accurate conditions of its financial health are of utmost importance before making an investment.