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.
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.
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.
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.
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)
There are several stages in an IPO. Once the company files for an IPO and its application gets approved, investors can subscribe to its shares within a set period. The share issue of a company in an IPO usually remains open for anywhere between three to ten days. During this period of IPO subscription, retail investors and others can file for allotment of the company’s shares.
The shares in an issue are allotted to the different categories of investors, namely:
- Retail Institutional Investors (RIIs),
- Qualified Institutional Buyers (QIBs), and
- Non-Institutional Investors (NIIs)
There is a cap of ₹2 lakh on the value of bids made by retail investors in an IPO.
There are three possible scenarios here – an IPO can be undersubscribed, fully subscribed, or oversubscribed. For shares of the company to be listed on the exchanges, the Securities and Exchange Board of India (SEBI) requires at least 90% subscription to the issue. Otherwise, the IPO is scrapped, and the money is returned to bidders.
An IPO is said to be oversubscribed when the number of shares on offer is less than the demand for the same during the IPO subscription process. This means that investors have applied for a greater number of share lots than what was put on offer by the company.
Oversubscription of an IPO shows a high interest of the public in the shares of the company.
For the retail investor category, SEBI says that if this portion of an IPO is oversubscribed, then the share allotment must be done in such a way that each investor gets a minimum of one lot, and the remaining shares must be allotted proportionately. This holds true for issues with a small oversubscription. However, if an IPO is oversubscribed to such an extent that all investors cannot be allotted a minimum of one lot each, then the share lots are allotted to subscribers using a lottery system. In such a case, many subscribers may not be allotted any shares at all!
If you’re wondering whether to apply for an upcoming IPO subscription or not, contact Share India today and get access to relevant information and research. Share India also shares expert analysis for every IPO opportunity (for FREE, accessible online on our websites and social channels) that can help.