From January to March 2021, as many as 22 companies filed for IPOs mopping up as much as USD 2.5 Billion. However, many analysts believe that this is only the tip of the iceberg. With a large number of IPO stocks lined up for the coming months, 2021 is believed to be a record year for investing in IPOs in India. Many of the IPO stocks listed in 2020 are already trading above their issue price, with some having gained as much as 400% since listing. All these make IPO investing an exciting option for investors looking to enter the market. However, one needs to remember that like all things in the equities markets, IPOs to come with a fair share of risk, and due diligence is required before investing in an IPO.

What is an IPO

Initial Public Offering or IPO is a market event in which a company offers fresh shares for sale to investors. Both institutional and retail investors can participate in IPO stocks and for this reason, IPO investments are keenly watched by investors. The price of the company’s stock is determined by the issue sale during the IPO and may either go up or down depending upon the level of investor interest in the company’s stock.

Things to Look Out for Before Investing in IPOs

1. Conduct Your Due Diligence

All companies that are listed on exchanges are bound by stock exchange regulations to publicly divulge key information related to finances and corporate governance that may affect their stock prices. However, these regulations do not apply to unlisted companies. Since a company about to head into an IPO is unlisted, it becomes difficult to gather information about it. Which in fact, only makes it more important for the investor to perform due diligence. You should try and gather all the information that you can about the company’s financials, past record, its promoters, etc.  You may even take the help of advisories and full-service brokers such as Angel One in conducting research.

2. Focus on the Fundamentals

Since there isn’t much information available in the public domain about a company listing on the exchanges for the first time, investors can try to get an idea about its valuation from basic fundamental analysis related to the industry it operates in. For instance, if the company is an auto-parts ancillary, researching the medium to long-term growth prospects of the auto industry, as well as the competitors of the firm can give you an idea of what fair valuation of the company’s stock should be. This in turn can lead you to a fair assessment of whether the price of the IPO stock is fair, undervalued, or overvalued.

3. Read the Prospectus Carefully

Every company heading into an IPO has to prepare a document called a draft red herring prospectus. (DHRP) The DHRP contains details about the company’s financials, its past performance, the profile of its promoters, the area that it deals in, its competition, etc. Thus, while the DHRP does contain a wealth of information about the company, it needs to be borne in mind that it is prepared by the company itself in association with the merchant bank that is undertaking the IPO investment, so all information must be double-checked from independent sources as well.

4. Monitor Institutional Investor Interest

IPOs are open to both institutional as well as retail buyers. Unlike retail buyers, institutional buyers as well as high net worth individuals (HNIs) have the resources at their disposal to perform in-depth research into companies since they are usually putting large amounts of capital into the IPO. As a result, a greater degree of institutional buyer interest in an IPO could be an indicator of a sense of confidence in the IPO by the market. However, this factor must only be used as an indicator, and not the primary reason for investing in an IPO. Institutional buyers may have a number of reasons for investing in IPOs, and it is never advisable to risk one’s capital in the equities market based solely on the actions of other participants whose motives are never known to us.

5. Use Technology

Smart work often yields better results than hard work alone. Given the state of technology available today, and the high stakes involved in an IPO, there are various algorithms and engines that can churn out investment recommendations by crunching the numbers. As a retail investor, you may not have access to such technology but you can always take the advice of a qualified investment advisory firm such as Angel One that has specialized teams dedicating to researching stocks and IPOs.

The Bottom Line

IPO investments are a great way to pick up value stocks, but they come with their own set of risks. Since not much information is available publicly about IPO stocks until they list in the exchanges, investors need to perform their own research before risking their hard-earned capital in IPO stocks. Always read the prospectus issued by the company carefully, and carefully evaluate the fundamentals of the business that the company is operating before investing in IPO stocks.