What to keep in mind when investing in an IPO?

Promoters often come up with new issues when markets are rising, say financial experts.

What to keep in mind when investing in an IPO

The pandemic does not seem to have doused the fire in India’s primary market, according to data released by brokerage houses. In the 10 months leading up to October 2020, market data reveals that new issues mopped up about Rs 18,000 crore - a considerable jump from the Rs 12,700 crore earned over the same period in the previous year.

Reports say 80 companies have approached market regulator SEBI (Securities and Exchange Board of India) to tap the primary market. By one account, 30-35 applicants have received approvals. One of the latest is Burger King India; thumbing its nose at the ruinous effects of COVID-19 on India’s restaurant business, this quick-service chain is seeking to raise Rs 542 crore with its Initial Public Offering (IPO). 

According to the papers filed with SEBI, Burger King will use the issue proceeds to finance new outlets. Clearly, the company is expecting economic activity to look up, even as fears over the pandemic dissipate and Indians start going out to eat once again.

Related: All About IPOs In India

An economic uptick

Equally clearly, others too believe in India’s resilience, and by all accounts, companies are undaunted by the current situation of the Indian economy. As a result, despite the ravaging effects of the pandemic, the IPO market of 2020 is looking promising.

As Jyoti Roy, DVP and Equity Strategist at Angel Broking, explains in Business Insider magazine, investors have been willing to invest in companies with profitable businesses and reasonable valuations. But then, Indian investors always seemed to have had a hankering for new issues. For instance, data shows that 8 out of the 11 IPOs listed in 2019 surged by as much as 95% even though the market was highly volatile.

This year looks even better for new issues, and as 2020 nears its close, the downturn could already be a nightmare of the past. Rajiv Biswas, Asia Pacific Chief Economist at IHS Markit, says data collected by his company points to “an improving economic growth momentum in the second half of 2020 and a positive GDP growth of 6.7% in FY 2021-22.”

In fact, according to IHS Markit, the medium-term economic outlook for India remains favourable. This is supported by a number of key growth drivers, including a large and fast-growing middle class. Biswas’s company envisages the total Indian consumer spending growing by 42% between 2020 and 2025 and doubling to $3.2 trillion by 2030.

Related: IPOs That Have Disappointed Investors In The Last 10 Years

Market buoyancy

All this bodes well for the stock market and IPO investment. In fact, according to Sampath Reddy, Chief Investment Officer at Bajaj Allianz Life, companies have begun “lining up for IPOs” because of favourable market conditions, and if they remain so, he feels more would join the line.

In an interview to Moneycontrol in September 2020, Reddy said a number of factors such as the opening-up of the lockdown, healthy recovery in various economic indicators, and even progress in COVID-19 clinical trials have helped the Indian markets to recover. 

As a result, the buoyancy in equity markets has encouraged companies, including existing large firms, to raise equity capital and strengthen their balance sheets and create a liquidity buffer to tide over the growth slowdown. This buoyancy is responsible for encouraging IPOs. 

Investors in new issues can take two lessons from Reddy’s analysis of the situation: first, if they take a long-term view of their investments, they can systematically invest in equities, and second, a well-diversified portfolio can be rewarding in challenging times such as these.

The sectors that Reddy says will do well in the current situation are IT, pharma, and FMCG. However, he warns that major geopolitical tensions or even a resurgence of the pandemic could impact liquidity flows and puncture the market buoyancy. So, given the current global situation, it is critical for investors - including new issue subscribers - to keep a long-term view.

Related: What Happens To Your Money If The Stock You Invested In Gets Delisted?

Investing smart

A long-term horizon is only part of the story; an IPO investment can fall flat if you invest blindly, for not all investments can guarantee healthy returns. It all depends on how the investment fares in the market - if it does well, you stand to gain immense profits; if it does not, you can kiss your money goodbye. 

The key to success in the market is to invest smartly, and the way to do it is by finding the right IPOs at the right price. Therefore, when considering any prospective IPO that has come into the market, ask yourself the all-important question: is this going to be a good investment for me?

To determine that, first get a fix on your risk appetite, your investment budget, and your financial goals. Once you get this right, you can narrow down your IPO search. But you must also know about the company you are investing in, so read the prospectus carefully to be clear about its financials, market record, and reason for issuing the IPO. Check for any red flags.

Also do extensive research on the sector the company operates in, to see if any critical information is missing in the prospectus. Further, it would be good to take the ASBA (Applications Supported by Blocked Amount) route when applying. With an ASBA application, you don’t block your funds but earn interest on it in your bank account. 

Related: ASBA And IPOs: All You Need To Know

IPO pricing

It is advisable to know how the IPO price is fixed; this helps you determine whether it is right for you. The company issuing the IPO will understandably want the highest price, whereas the underwriter will try to determine an acceptable offer price based on the company valuation. So, it is advisable to select an IPO that has a strong underwriter, such as a reputable investment bank or firm.

An IPO pricing is either a fixed-price offer or a book-built offer. In the first category, the company fixes the application price, while the second is a process of price discovery. 

In the case of book building issues, the offer document is called a ‘red herring’ prospectus - it does not contain details of the price, the number of shares offered, or the issue size. A red herring prospectus only has either the floor price of the securities offered or a price band within which the bids can move. The price is determined only after the bidding process is completed.

Related: Is Your IPO Rightly Valued?

You will be considered a retail investor as long as your bid is up to Rs 1,00,000; any higher and you will fall in the HNI category. You can check the allotment status either on the BSE website or the registrar's website after the issue closes.

Last words

If you want to seize the opportunities thrown up by a new company, an IPO investment would be ideal. Such investments also make sense for people with a good understanding of the market trends - plus of course, a degree of appetite for taking risks.

But bear in mind what Dev Ashish, financial analyst and founder of financial planning and investment advisory Stable Investor, says, “IPOs are generally overpriced.” As he writes in a by-lined article for Moneycontrol, what often goads companies to come out with IPOs is a buoyant mood among the investing public following a market recovery - just as it is now. The reason: a market recovery creates the perception that making money on the stock exchange is easy.

To sum up, it pays to follow the adage ‘don’t judge a book by its cover’ - or in this case, by the hype around a new company. Judge it by its fundamentals, read the prospectus carefully, and see if it dovetails with your financial goals.

Disclaimer: This article is intended for general information purposes only and should not be construed as investment or legal advice. You should separately obtain independent advice when making decisions in these areas.

Related Article