Five Questions to Ask Before You Invest in an IPO


With the IPO mania increasing day by day there will be at some point of time that you will make up your mind to invest in an IPO. Your broker or Financial Advisor would have sent you updates for investing in IPOs along with IPO forms. We also have been recommending IPOs as due to liquidity that is where the money is made easily. However, before deciding to invest in IPOs it will really help you if you ask the following 5 questions about the company.

1. Who gets the money?
The whole point of an IPO is to raise money. But who gets the cash? Sometimes it is the founding shareholders, who are usually management. If these insiders are selling, what does it say about the companys prospects? Nothing good. However, the founding shareholders of a company may be looking to take some cash off the table after spending their time and money building the business. They may want to diversify their assets – or maybe buy an airplane for themselves. However, its much more encouraging if the proceeds are used for the companys further development and expansion. And in any case, the founding shareholders should hold on to a significant stake so that they still have skin in the game.

2. How does the business make money?
A company coming out with an IPO is generally looking to grow and uplift its brand. An IPO gets a lot of attention for its brand. However, one must see how does the company really make money? Is there just a fad or is it a real profit. The recent example of SNAP (the company that manages the app called SNAPCHAT) going for an IPO – the company is barely making any money and is still loss-making. Then why would you invest in that just because it is a fad! Don’t jump into it just because everyone is buying into the IPO.

3. What is the performance of other companies in the same business?
Everyone invests (the large retail public) invests in 
IPOs for quick returns from the liquidity boom. Lets face it! We are all greedy for the small quick gains as it gives excitement and also some returns. So how to decide whether your decision to invest in the IPO will help you achieve that? Look at the Industry that the company belongs and check the last 6 months returns of similar stocks in the same industry. If the returns are very good then go for it and invest as the chances of making money on the listing is high.

4. Check whether SMART money is investing in it or not?
Look for HNI (High Networth Investors) funding book. If the funding book is high then the probability of making quick returns is also high. You can ask your broker or Lead managers what is the funding that is going to happen in the particular IPO. The approximate figures are available with all brokers. There is no surety that if the HNI funding is large then the IPO will get listed in a premium it could also open negative as it is all speculative.

5. Are the shares expensive or cheap?
The shareholders who are selling want to sell at a high valuation level (based on measures like the price-to-earnings ratio, for example). Investors buying into the IPO, meanwhile, want a low valuation so that the share price has room to rise.

The big question – as with any valuation exercise – is what the stock price is being compared with. The people selling the IPO will point to companies that trade at high valuations – so that the shares they are selling will appear cheap by comparison. The shares of companies that are direct competitors in the same country and sector, with a similar growth rate, are generally the best ones to look at.
Generally, PSU (Govt. of India undertaking) companies come out with reasonable valuations so that money is left on the table to be made. This had happened with certain landmark IPOs such as Coal India – which came out at very reasonable valuations and all the investors made a lot of money on the listing and in a few months. HUDCO was another such example, it took time for the market to react but investors made good money. Conclusion

IPO investing is fun and exciting and the IPO boom phase is generally always beginning of a new Bull Market. So while it lasts enjoy it and make sure to get your money out at the right time. Is it only and only driven by Liquidity.

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Good luck with IPO investing!

Vatsal Shah | Head - Wealth Management
He has been in the field of financial advisory for more than 8 years. His strength is building relationships and providing innovative solutions to investments. His work involves managing the wealth management department for Mutual Funds, IPOs, Bonds and Insurance.

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