Investing in an IPO may get you good returns but tread with caution

In the past eight years, 283 companies have raised money via IPO and 157 are yet to return any profit to their investors.

Before investing in an initial public offer (IPO), retail investors typically rely on analyst reports or advice from friends who are well-acquainted with the stock market.

But it pays to do your own research, as investors tend to burn their fingers in IPOs.  

About 55 per cent of the public offers that hit the market since 2008 are still trading below their issue price.

In the past eight years, 283 companies have raised money via IPO and of these, 157 are yet to return any profit to their investors.  

“Brokerages do come up with research reports on the issue but when it’s your money at stake, you should take responsibility for it, rather than relying on another person’s analysis,” says Sanjiv Bhasin, executive vice-president, IIFL.  

The IPO document, called the red herring prospectus (RHP), is a bulky book with 500 pages of information.

Experts say it’s written keeping the regulator in mind rather than small investors. But you can still look at the relevant sections to evaluate the company and decide if it merits your money.  

Girish Nadkarni, managing director, investment banking, Motilal Oswal Investment Advisors, says the summary section of the RHP gives a gist of overall business and financials. “All RHPs contain summary of industry, businesses and financials. That’s a good place to start.”  

To understand the business in depth, go to the section that talks about industry and business structure.

This section discloses all the points related to running a company, how a company works, and makes money.

It even covers SWOT analysis. Amarjeet Maurya, senior research analyst with Angel Broking, says this will help the person understand where and how well-placed the company is compared to peers.

Once you understand the business, the next thing to look for is why the company is raising money, available in the section that states the objective of the issue.

Sachin Shah, fund manager and head PMS at Emkay Global, explains an investor should read this carefully and then take a call on whether the additional funds would help the company grow faster and/or improve its operational performance.

If the company wants to mainly retire debt from the fund raising or if it is an offer for sale by existing shareholders, it might not really be a good thing.

Then, look at its performance in the past three-five years. Shah of Emkay says investors should evaluate the liquidity position, reserve build-up over the years, debt to equity ratio and profitability trends.

It’s also essential to understand the sector the company operates in and how well it can maximise the opportunities to deliver strong and profitable growth for its shareholders.  

Once you know the business and financials, you get a fair idea of past performance. To understand future risk, the investor should look at the risk factors, specifically, the internal ones.

Hiren Dhakan, associate fund manager at Bonanza Portfolio, gives an example of IndiGo. There are only two prime suppliers of airplanes, Boeing and Airbus.

The risk here is a sudden hike in airplane prices by both companies, which can have a bearing on the expansion plans of airlines.

Finally, a business is all about the people who run it. RHP not only has detailed information about the background on the management but also gives a fair idea about how experienced is the management and how they plan to run the operations  in the near future, their vision and areas of focus the that management sees as befitting.