How to do Analysis of an IPO and 7 Factors to Consider it
One of the best ways to build wealth in a stock market is by investing in an IPO. With the growth of the company wealth of investors grows too. But investing in an IPO comes with its own risk, there have been instances of companies performing very badly. That is why conducting proper research and analysis of upcoming IPOs is very much needed for an investor. Proper analysis helps in making better investment decisions.
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What is an IPO?
Any private company initially grows its business by utilizing the funds provided by friends, family, founder capital, angel investors, and banks. When a company realizes it has achieved its specific goals and to achieve more goals like business expansion in other countries or regions, and reducing high-cost debt it needs to tap into public investors. This is the phase when the company raises funds to achieve its business goals, from the general public by selling fresh shares of stock.
Components of an IPO::
Any IPO has basically two components – Fresh Issue and Offer for sale. Before analyzing an IPO it is very much important to know the difference between the two of them.
Fresh Issue :
A process in which a company decides to issue new shares of the company and sells them to the general public for the very first time during an IPO is called a Fresh Issue of an IPO. The money received in Fresh issue is used by the company for its growth plans and to achieve other goals.
Offer for Sale IPO :
A process in which the company sells the shares held by the existing promoters/investors of the company. The money received in OFS is used by the promoters/investors and not the company as compared to fresh issues.
Factors to Consider Before Investing in an IPO?
The factors to analyze before investing in an IPO are as follows:
Grading: CRA(Credit Rating Agencies) provides grading to an IPO.
Grade 1 = Poor company fundamentals.
Grade 2 = Below-average company fundamentals.
Grade 3 = Average company fundamentals.
Grade 4 = Above-average company fundamentals.
Grade 5 = Good/strong company fundamentals.
The decision about whether to make an investment in an IPO should be based on their grading, good decision is to invest in companies having strong fundamentals.
Proportion of Fresh Issues and Offer for Sale (OFS): If OFS is greater than Fresh Issue then it Indicates that promoters are selling their stake. If 100 % OFS not a good decision to invest.
If OFS is lower than the Fresh Issue: it usually indicates the company’s good future growth outlook as promoters not selling their big stake, they have conviction in their business and it’s a good decision to invest in the company.
Financials: Companies’ finances play a vital part in making a decision before going for an investment in an IPO. Analyzing the past few year’s performance of the company ensures that whether it’s profitable or not. Also, a good company should have good cash reserves as well as consistently increasing revenue with a low debt burden.
Objective and Purpose: While analyzing the Red Herring prospectus of the IPO issue, it is very important to check how the company will use the funds raised in the IPO. If funds are used for expansion plans then it is advisable to invest in it. Funds raised should not be used to pay off debts. It is advisable not to invest in companies that plan to use the funds to pay off existing debts.
Demand: One of the best ways to select an IPO is by checking its public demand. If public demand is very high, the IPO will be oversubscribed, and if undersubscribed it means public demand is low and the stock might not be an ideal investment decision to take.
Future growth prospects: As an investor a very good decision to invest in a company is to check the growth plan of the company. The company wants to use its capital to expand and to compete with its competitors can be a worthwhile investment prospect.
Assess financial ratios: The investor should have knowledge of whether the shares are overpriced, underpriced, or reasonably priced. They can assess various ratios like P/E, P/B, P/S, and ROE to analyze the financial valuation of the company and to compare with same sector companies already listed and with sectoral index.
Note:
Irrespective of the above factors, the investor needs to make his/her own independent decision regarding investing in any issue after studying the contents of the prospectus including risk factors carefully.
Conclusion:
Investing in an IPO, especially for the first time, can be an intimidating task. Hence, a guide for performing an analysis of IPO can come in handy. There can be no better alternative to decisions made by thorough analysis backed by substantial data. If you are wondering how to analyze an IPO, do keep the above-mentioned pointers in mind.
