IPO season: 5 factors to look at before investing

Amitabh Tiwari
·4 min read

A booming stock market, wherein indexes have doubled from their lows in March last year, have given way to many primary issuances / initial public offerings. Market flush with liquidity have pushed them up globally. Work from home option has created a new category of Robinhood investors. The interest in stock market investing has soared significantly.

In 2020, 15 companies got listed and raised around Rs 31,000 crore. In 2021, till date, 13 companies have come out with their offerings and listed on the stock exchanges, raising around Rs 16,000 crore. The average listing gains for IPOs that hit D-Street in FY21 are at over 70 percent, the highest in at least 3 years, suggest experts.

Investors have made money in the range of -4% to 89% as listing gains. IRFC has been the worst performer while MTAR has given the highest returns as shown below. Another 12 to 15 companies are expected to hit the market this year and raise around Rs 80,000 crore.

LIC is likely to go public this year. With a number of IPOs hitting the market, what should be the strategy of an investor? How should he decide which IPO to invest in and which IPO to skip?

As per a research by IIM Trichy Professor P. Saravanan, “For every high-profile IPO which provides significant gain on its day of listing, there are many newbie shares that disappoint investors as the long-term performance of IPOs is underwhelming.” So one needs to adopt a cautious approach.

IPO listings in 2021 till date

(Source: www.groww.in)

The five factors which investors should look at before investing in IPOs are as follows:

1. Read the DRHP

All companies which want to go public are required to file a DRHP (draft red herring prospectus) with the SEBI. It contains important information regarding the company’s business profile, financial statements, capital structure, objective of the issue, use of proceeds, management views, risk and mitigants, etc.

As it is often said, the devil is in the details and the fine print. The risk and mitigants section of DRHP could scare the hell out of most investors. The DRHP provides investors with all the necessary information about the IPO, and helps to decide if the company is worth investing in or not. It is a bulky document and requires a lot of patience to go through.

2. Check management track record

Investors should find out about the promoters, their credibility, management team and their qualifications. Do they own any other company? If yes, how are they performing? What is the reputation in the market? Do they have any past issues with SEBI or banks? Are they first generation entrepreneurs? How have they made their money?

3. Read IPO Grading report if any

Many IPOs are nowadays graded by rating agencies. As these agencies are more conservative compared to equity brokerage houses, their reports are usually more balanced. These reports are also not as bulky as DRHPs and provide the investor with a quick recap about the company.

4. Check QIB participation

QIB participation is considered by many to be a barometer of the stock’s future performance. QIBs are SEBI-registered financial institutions, banks, mutual funds, and foreign institutional investors (FIIs). This number can be tracked, however, it should not be the sole criteria.

5. Objective of the issue

One should always look at the use of the proceeds section. For what purpose the IPO money is being raised? Are the current promoters / investors exiting and money will go to their pockets? Or is the money being used for expanding capacity, growing business, R&D, expanding footprint etc.?

Listing Gains or Long Term View

Many investors invest in IPOs just for the sake of listing gains. Past experience shows some stocks make a bumper listing, while others don’t. If the investor wishes to hold the stock for medium to long term, then the quantum of research he / she needs to do is much more.

The funds are b;ocked for a period of 7-8 days. The opportunity cost of this should also be considered while calculating expected returns. Since the retail portion in most IPOs is subscribed multiple times, with the amount of investment is capped at Rs. 2 lakhs, even if one’s bid is successful, one may get far lesser number of shares than subscribed, limiting the gains in absolute terms.

To sum up, investors should not consider IPOs as get-rich-quick instruments and consider all aspects before investing.