Investors are people. They like novelty; get excited by something new, especially if it holds the promise of making them a whole lot richer. Be careful. Amateur and professionals alike tend to lose their minds in bull markets, particularly when a hot initial public offering, or IPO, makes its appearance in the market.
Just because a company persuades an investment bank to take it public doesn't mean it's a worthwhile investment. Here are a few guidelines that may help you make the right choice while selecting an IPO for investment. Please read the offer document and study the IPO issue with the following considerations in mind:
- Understand the real need for the product or service this company is planning to market. As we said earlier, new issues often come to market in industry clusters. As a result, not every company going public has a viable product or service to offer.
- Study company performance. It is important that the company has a track record of good operational performance indicated by figures of sales, profit, EPS etc. You must also look at the performance of the group companies and the inter-company transactions within the group, ensuring that there are no dubious transactions. If any loans are given to the group companies, you must study whether they are paying reasonable interest and whether the loan is likely to be repaid.
- Check promoterís background, the experience he has in the industry, the performance of the other companies promoted by him, his track record, investor complaints etc. Read the risk factors very carefully, especially those pertaining to the promoter/management. Check for any serious litigation against the promoter or the company.
A good promoter or management team ensures regular growth in the company, by constantly looking for new business expansion opportunities. In the short to medium term, businesses may face ups and downs, but long term success can be significantly influenced by good management which takes all necessary steps to ensure profitable performance. With a reliable and trustworthy management in charge of the company, you can be reasonably sure that your money will not be deliberately misused or siphoned off.
- Study future prospects of the Company, including expansion plans, plans for utilisation of funds raised, etc. Future prospects play an important role in the performance of the scrip on the stock exchange.
Some investors feel as though they just donít "get" a company's vision. Very often, this may happen because the company may not have a vision at all. This is something investors must watch out for in a hot IPO market where several companies with no path to profitability go public.
- Evaluate fair price. Based on factors such as the fundamentals of the company, the companyís EPS and the average industry PE, you can derive the fair price of any scrip. On comparison with the issue price, you will be able to conclude whether the issue is undervalued or overvalued. In case the issue is overpriced, it will tend to quote below issue price over a period of time, making it profitable to enter later at a lower price, rather than at the IPO stage. A high price is likely to reduce the prospects of appreciation of the scrip at the exchange, thereby defeating your purpose of investing.
- Have patience. If you truly believe in the company's products, strategy, and management, buying its shares and holding on for a long time will make you a lot more money with a lot less work than will trading new issues recklessly. This does not mean you should never sell, of course. Just make sure you are selling because the companyís fundamentals have changed, not just because the companyís stock price has gone down.
With these investing principles in mind, you have a much higher chance of having a successful IPO investing experience.