4 Things to Look for Before You Invest in an IPO

Published by Sharekhan Education | October 9, 2021

4 Things to Look for Before You Invest in an IPO

Initial public offerings are favored by investors when market sentiments are good or euphoric. It happens because companies can leave less on the table for the investors and still manage to get successfully listed on the exchanges during these times. For long-term investors, it becomes necessary to look at the quality of IPOs during such times. Usually, the worst of the companies manage to scrape it through during such times and get listed.

So what are those four things that an investor should look for when investing in an IPO?

Check the objective of coming out with an IPO:

An investor needs to check where the company will deploy the money raised through the IPO.

a. Is the company going to deploy the money into assets or pay off its liability?
b. Would the company utilize it to carry out the disinvestment of equity shares by selling shareholders? Is it just for getting listing benefits?
In example A, you can see money gets utilized to drive future growth and profits. But in example B, it is not the case. An investor should be careful to invest in IPOs, which will generate future growth. IPOs that do not focus on utilizing the money for future growth prospects are not a good investment.

Understand the sector and business model:

An investor needs to analyze whether or not the company operates in an industry with favorable growth drivers. For example, during the COVID crisis, sectors such as pharmaceuticals, telecom, specialty chemicals, and IT had better growth prospects. Also, analyzing a company’s products, customers, competitors, management reputation, costs, and revenue economics helps to gauge the financial success that the company will have in the future. It also helps to understand the impact on the company in the event of an adverse event.

Gauge the financial strength:

It is of utmost importance for an investor to invest in a financially sound company. Companies with robust profit and loss, balance sheet, and cash flow are most preferred.

Check the valuation:

An investor should always check the valuation ratios such as PE, PB, EV/EBITDA against the peers of the company in the industry. An IPO offering shares at a valuation that is relatively cheaper than its industry peers is always preferred.

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