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Should You Invest in IPOs? Factors to Consider for Smart Investing

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Seeing a rush of successful Initial Public Offerings (IPOs) in India and a huge number of investors seeking to encash attractive listing returns, it is important to be able to evaluate investment opportunities yourself instead of simply buying into the general craze.

So, should you apply for every IPO that is announced in the primary markets? How do you decide which one is more attractive in terms of long-term holding returns or immediate listing gains?

Reading the IPO prospectus is always a good place to start, and then there are other factors to consider, which we have highlighted in this article.

Let’s discuss what questions investors should be asking before investing in an IPO and how you can avoid IPOs that are not likely to succeed in the short or long term.

Here are some of the critical factors that should be considered before investing in an IPO.

1. Understand the motive behind the company’s IPO and use of funds.

As companies going public seek to raise funds from investors, there should be a clear statement in the prospectus about how the money will be used.

Knowing where your money is going should be important to you and will play a role in the performance of your investment. Companies that are putting the funds raised back into the business will have a greater incentive for the business to grow, versus when early investors or founders are primarily cashing out their held stocks for return on their investment with ambiguous expansion plans.

It is also important to keep a sharp lookout for anything that will benefit third parties, such as excessive fees being paid out to advisors, as occurs in some floats. Overall, companies putting funds towards growth initiatives are more likely to have a greater long-term outlook and provide a more stable investment.

2. Understand the company’s business.

Investment guru Warren Buffett attributes his success partly to remaining within his ‘circle of competence’. If he can’t work out what a company is doing, he believes it is highly likely that lots of other people have the same difficulty; therefore, he stays away. And he’s right.

It is simple yet integral advice and something to keep a close eye on when investing. Companies should be clear in the prospectus about what their product or service is, the problem they are solving, or the gap in the market they are filling.

Once you understand the business, identifying the market opportunity is your next step. The size of the opportunity and the company’s ability to capture market share can make all the difference when it comes to growth and shareholder returns.

3. Be clear with your investment strategy/goal.

Before investing in any IPO, one should have a clear investment horizon. You need to decide if you are planning to invest in the IPO for just trading purposes on the listing day or if you want to hold the shares longer. The reason behind this is that a trading strategy could rely more on current market situations, hype, and broader public emotion (more in point #4 below), while a long-term strategy will hinge on the company’s fundamental analysis.

4. Observe the public emotion.

Public sentiments towards macroeconomic factors, government policies, business branding, public relations (PR), corporate social responsibility (CSR), etc., could also influence listing gains, at least in the short term.

As already discussed, a vital factor to keep in mind before investing in a new IPO is to focus on the reasons you want to invest in the first place. Establish a clear and strategic reason to purchase the shares and check off the herd mentality or emotional turbulence to stick to your research and analysis.

Frequently Asked Questions (FAQs)