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How to Identify Good IPO Investments

IPOs are buzzing these days, with many companies coming forward to list on the Indian markets. Investors are presented with a wide variety of IPOs in both the main board and SME segments. Determining the most promising IPO to invest in can indeed be a challenging task.

In this article, we will explore some quick evaluation criteria to help identify a sound IPO investment. 

Every retail investor wants to participate in IPOs, but many of them may not be aware of how to find a good IPO. Due to a lack of knowledge and information, investing in IPOs can lead to capital erosion.

Let’s delve into the evaluation criteria one by one:

Business Strength

Commence your assessment by thoroughly examining the company’s business model, the credentials of its management team, and its historical performance.

A valuable starting point is the red herring prospectus, which all companies going public are required to provide. It contains a wealth of information for your evaluation. Additionally, consider consulting the company’s website, annual reports, and media coverage.

Invest only if you are genuinely convinced of the company’s robust business model, financial stability, revenue potential, and the quality of its management. Assess factors such as the company’s position within its industry and any distinctive attributes that give it a competitive advantage.

Growth Potential

A strong past performance does not guarantee future revenue growth. Given that stock prices reflect future growth, prioritize IPOs where the company demonstrates significant growth potential.

Initiate your analysis by evaluating the growth prospects of the industry in which the company operates. Then, estimate how the company’s market share is likely to expand in the coming years.

Factors such as technological investment, innovation culture, market expansion initiatives, and the leveraging of identified strengths should be considered. If the company appears to excel in these aspects, it may be a favourable IPO investment.

Promoter Intentions

Investigate the extent to which the promoter group is diluting its stake before investing in an IPO. While the law mandates promoters to hold a minimum of 20% after an IPO, successful companies often retain a larger share.

Significant dilution may indicate a lack of confidence from the promoter group, a lack of long-term commitment to the company, or potential irregularities. You can gauge management’s intentions by examining their withdrawals from the company.

Be cautious if a company pays hefty remuneration and large dividends to management while also substantially diluting its stake through the IPO.

Use of Proceeds

The intended use of the IPO funds can be found in the red herring prospectus itself. The best IPOs typically allocate funds for growth-related investments, such as new technology adoption, market expansion, establishment of production facilities, or business acquisitions.

Ensure that the company has a well-defined growth plan and that the intended use of proceeds aligns with this plan.

IPOs that primarily aim to repay old debts, settle claims, or make working capital-related investments may not be as promising.

Pricing

Avoid investing in an IPO solely based on a company’s popularity. A recognizable brand name is just one factor that distinguishes a promising IPO. Well-known companies may set their share prices higher than their actual value, resulting in oversubscribed IPOs.

Read: What is Grey Market Premium?

You can estimate a fair stock price through competitor analysis, using metrics like Price-to-Sales and Price-to-Earnings ratios.

Calculate these ratios by dividing the company’s stock price by its sales per share and net income per share, respectively. These figures can be found in the company’s income statement. If these ratios exceed those of competitors, it may indicate an overpriced stock, warranting caution.

However, there are instances where higher pricing is justified due to the company’s superior qualities. A comprehensive analysis of the company’s history and prospects will help determine if this is the case.

So, from next time onwards, you should consider these criteria before investing in an IPO. Not only will it help you choose a better IPO, but it will also help you protect your capital and make wiser investment decisions.

Disclaimer: This blog has been written exclusively for educational purposes. The securities mentioned are only examples and not recommendations. It is based on several secondary sources on the internet and is subject to changes. Please consult an expert before making related decisions.
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