The IPO market is inherently volatile, influenced by the prevailing sentiments in broader financial markets. Nevertheless, it is a crucial element of the financial and securities ecosystem. Numerous IPOs have created substantial wealth for investors. However, both new and seasoned investors must master the art of identifying high-quality IPOs. At first glance, many IPOs may seem promising, but adopting a long-term perspective is where the true challenge lies. Here are 5 steps how to find good IPO?
Investing in IPOs is different from trading stocks. Many new investors quickly invest in any available IPO. However, it’s important to understand the company’s business and operations. The IPO selection process should consider the management’s history, risks involved, and the reasons for raising funds. Examining the red herring prospectus (RHP) is crucial as it provides important information. This is why SEBI requires full disclosures.
Pricing in absolute terms is often misleading. An IPO priced at INR 10 per share can seem costly, while one at INR 50 might appear cheap. While pricing is important, it should be looked at in relation to profits and business growth. The stock market is all about future potential, often willing to pay a high price for companies that show promise of great growth. In bull markets, ambitious promoters frequently set IPO prices very high, leaving little or nothing for investors. It’s important to consider a safety margin since factors like the grey market premium (GMP) can quickly disappear with any signs of trouble in global markets.
Many investors expect quick gains from IPOs, but it’s crucial to understand the sector you’re investing in. If the market changes and shares launch at a lower price, be ready to hold onto your shares for at least six months. For cautious investors, jumping into an IPO of a new technology company can be risky and may result in losses.
Factors like past performance, number of years in business, and growth prospects can provide valuable insights for spotting promising IPOs. Market share serves as an excellent indicator, particularly in emerging sectors where potential profits are still on the horizon. Looking ahead, numerous green energy players are poised to enter the primary markets, presenting exciting opportunities. While many of these companies may not be as profitable as IREDA initially, a leading player in its sector should be viewed with optimism, as every experience can lead to future growth and success.
Companies often claim there are no comparable businesses to support their high IPO valuations, but such assertions are frequently unconvincing, as analogous examples are usually available in other sectors even without direct competitors.
Promoters should have a vested interest in the company. If the promoters of a struggling firm are among those selling shares in an IPO, it can be discouraging for retail investors, as they may question the potential for future growth and stability. Likewise, IPOs with a significant Offer For Sale (OFS) component may not be ideal for small investors, who often seek opportunities that indicate confidence from the original stakeholders. After all, why would an investor choose to exit a thriving business? When promoters sell their stakes, it may signal a lack of optimism about the company’s prospects, which can heighten concerns among retail participants who rely on the promoters’ commitment to drive the company’s success. In contrast, when promoters demonstrate their dedication by holding onto their shares during an IPO, it typically reassures the market and attracts more investment, fostering a healthier environment for both the company and its investors.
Private equity investors typically exit their investments after 4-7 years, and their complete exit can indicate unfavorable conditions for IPO investors. Conversely, when a notable external investor retains a stake in a profitable business, it signals confidence in future prospects, helping to identify promising IPOs.
Another effective strategy for investors seeking promising IPOs is to assess whether promoters are compensating themselves excessively. Businesses should prioritize profits for shareholders, and if promoters are the sole shareholders, it can lead to troubling situations. Promoters may pay themselves too much, which is generally a red flag. This issue is common among first-generation entrepreneurs and SME IPOs, where internal controls are often weak, and the lines between the promoter and the business blur.
If promoters have previously extracted profits from a business, they may continue to do so after the IPO, using methods like unperformance-linked remuneration, high dividends, or related companies charging inflated prices. Investors should avoid companies that have been overly generous to their promoters in the past.
Conclusion
Overall, long-term IPO investments are highly rewarding, especially when the selection process is meticulous. It’s crucial to understand the company in detail before making any investment. Long-term investors maintain their composure during market fluctuations, confidently awaiting improved conditions. In contrast, those aiming for short-term gains should promptly sell their shares whenever profits present themselves.
