Key things to keep in mind while investing in an IPO: DRHP, Capital utilisation, Company background, etc.

Should you apply in each IPO just because of the market frenzy?

An Initial Public Offering (IPO) is the process by which a company’s shares are offered to the public for the first time. A private company launches an IPO in the process of getting itself listed on the share market and becoming a public listed company at the end of it. The company raises equity capital from the public by issuing the company’s shares.

The company issuing the IPO is known as the issuer and undertakes the process with the guidance of one or more investment banks as consultants. After the shares of the IPO are allotted to the public, the shares can be traded in the secondary market by investors. 

Here are some key things to keep in mind while investing in an IPO:

Draft Red Herring Prospectus (DRHP)

DRHP is a mandatory document that the issuer needs to submit to SEBI before launching an IPO. It discloses the post-IPO plans of the company and the risks that investors are likely to assume. Going through the DRHP is recommended for every IPO investor.

Capital utilisation

How a company plans to utilise the capital raised through the IPO will decide the future growth of the investment made by you. If the company has business expansion plans and a promising action plan, you could consider applying for the IPO. If it plans to pay off debts with this capital, there is not much to look forward to in terms of growth prospects.

Related: IPOs that have disappointed investors in the last 10 years

Company background

The background and track record of the promoter is important for the growth of the company. So is the pedigree of the top management and the number of years of experience they have in running this and other companies.

Business understanding

You should understand the nature of the business. It is better to skip a company if it is from a sector that you are not confident about, or if you don’t understand how the business runs. If you follow the business, you can make informed decisions about your investments in the future.

Industry comparison

It is important to check how the company stands against its peers. Investors will find competitor analysis in the DRHP as well. By looking at the financial numbers and analytics, you can estimate the market prospects of the company in the face of the competition in the industry.

Valuation of the company

You will find information on the recent financial performances of the company. How much sales and profit it has generated, how much debt it owes, what its assets are, how healthy the business ratios are, etc. will indicate the financial health of the company.

Related: How attractive market conditions have led to the best start to IPOs in 20 years

Investment horizon

Investors apply to IPOs to make a profit on listing day or while keeping a long-term investment goal in mind. However, investments shouldn’t be made in a company solely for a quick profit. The company should have strong fundamentals that can realise long-term value for the investor. If short-term profit is the only target, the timing of the IPO and the prevailing market sentiments should be considered. 

An investor must identify the right IPO for investments. Only when a company convinces you with its fundamentals and plans should you should go for their IPO. This will ensure that your investment is always in line with your risk appetite and your financial goals. 6 IPOs to look forward to in 2021