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Tips and Strategies for Investing in IPOs

Tips and Strategies for Investing in IPOs

An IPO investment, by default, is a very comprehensive process and you need to understand what you are investing in. However, there are some basic tips and strategies that you can use like how to look at BRLMs, how to evaluate the price, how to research promoters etc.

The whole idea of giving tips and strategies to invest in IPOs is to provide a quick framework on which to base your IPO decision. Remember, investing in IPOs is just like investing in any share in the secondary market. The only difference is that in most cases you do not have any track record of the listing performance. Also since not much information is available in the public domain, you have to rely on the prospectus of the IPO to take a view on the company as a whole. Here are 5 thumb rules that you can follow to invest in an IPO.

5 Thumb Rules on How to Invest in an IPO

New offer versus OFS
Is the IPO a new issue or an offer for sale (OFS)? An OFS is an exit by an existing shareholder. It could be the promoter, the anchor investors, PE investors etc. If the stake sale is leading to substantial dilution or exit, then you need to be cautious. The only difference is that OFS does not dilute equity unlike a new issue of shares.

Track Record
Check the past performance of the company. Don’t just look at the sales and net profits figures but also look at key profitability and efficiency ratios for the last few years. More than the numbers; focus on the consistency of performance. That is what makes a real difference to the long attractiveness of a stock.

Promoter checks
In an IPO, the promoter pedigree matters a lot. If the IPO is from a reputed business house with a long standing in the Indian market, then the investor interest is already there. Focus on business groups that follow standards of transparency and corporate governance. That is what matters to valuation in the final analysis.

Sector benchmarks
Check with the industry standards if the numbers projected by the company are credible or not. For example, if a mini steel plant is forecasting growth at 25% per annum when the industry is growing at 8%, then there is obviously something wrong somewhere. Be cautious with IPOs where the promoters are trying to be too aggressive in their projections of the future.

Capital dilution
Check out the post issue capital base of the company and the debt of the company. The capital structure matters a lot. Both cannot be too dilutive. For example, if your capital base is too huge, then you will never be able to earn enough on a per share basis to reward shareholders. We saw that with infrastructure companies in the last 10 years. Similarly, companies with a high debt/equity ratio are always basket cases for getting into financial strain. Such companies are best to be cautious about.

Three Cases of IPOs to Avoid to be on the Safer Side

While there are no hard and fast rules, here again you can use some basic benchmarks.

Legal issues pending
If the company in question has too many legal cases pending against it, unexplained contingent liabilities, too many red flags by the regulator, environmental litigation pending, auditor qualifications etc then such stocks are best avoided. It is apparent the company is just too lax on the legal and compliance front and that does not give you too much comfort.

Too diversified business
Be cautious of businesses that spread themselves too thin, Historically, IPOs that have created wealth are the ones that have a much focused business model. Take the case of stocks like Avenue Supermart, Shankara Building Products etc. These are very focused and profitable plays in their respective spaces and they have kept investing into their core businesses only. They stand the best chance of being wealth creators.

Use of IPO funds
Check out how the funds are being utilized. If the funds from the IPO are going to expand operations or build new capacities, then it is understandable. Be cautious of companies that are going to use the IPO funds for real estate acquisition or rolling over of loans is not a good idea.

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