To Buy Or Not To Buy: How To Decide While Investing In An IPO?

An initial public offering (IPO) is a first time issue of equity shares by a company to all public investors. These include retail, high net worth and institutional buyers.

 

Through this process the company converts itself from a privately owned entity to a public listed company.

 

These equity shares after allotment to the public get listed and traded on a stock exchange like the NSE (national stock exchange) and/or the BSE (Bombay stock exchange)

The reasons for the company to offer equity shares are:

  • To raise fresh and cheaper capital for future growth
  • To repay previous debt and/or working capital
  • To allow early private investors to sell their shares
  • To enlarge and diversify the base of shareholders
  • To increase public visibility
  • To enable to fund future acquisitions (in return for equity shares)
  • To fund the expenses of the public offering and the listing of shares

 

It will always be wise for all potential buyers do adequate homework using the detailed information, which is given by the company in the issue offer document as well as by scanning more information on the Internet.

 

This detailed information is also filed with the market regulator SEBI.

 

You can click the link below to view and download any draft offer document.

 

http://www.sebi.gov.in/sebiweb/home/list/3/15/10/0/Draft-Offer-Documents-filed-with-SEBI

 

One should spend time and effort to read and study the following factors very carefully before making a decision to buy or not to buy:

 

  • The back ground of the promoters and their track record

 

The educational qualifications and relevant industry experience of the promoters, past record of setting up or working in similar companies in their career.

 

Care should be taken to check whether or not the promoters have had any past civil or criminal legal cases against them in any court of law.

 

  • Industry background and current growth potential and key challenges

 

Status of the industry that the company belongs to, the current growth potential as well as key challenges the industry faces in terms of demand, supply, volume growth, market growth, availability of relevant products, role of pricing, role of technology, legal regulations, environmental factors, importance of innovation, customer needs etc.

 

  • Company’s past performance with analysis of balance sheet, profit and loss and cash flow statements

 

Balance sheet and profit and loss statements

 

Performance of past 5 years in terms of sales growth, operating revenue, profit margins, profit growth (before and after tax), debt to equity ratio, interest cost, operating cost, growth in net current assets (current assets less current liabilities), growth in book value, earnings per share, rate and quantum of dividends paid, increase/decrease in net worth, amounts receivable and payable.

 

Analysis of ratios of past 5 years of Return on equity (ROE), Return on Net worth (RONW), Return on capital employed (ROCE)

 

 

Cash flow statements

 

Cash flow statements of past 5 years should be checked for cash inflows and outflows, positive cash flow per share, operating cash flow ratio, whether profits which are shown in profit and loss statement match with the cash flow statement or not

 

  • Pricing and valuation

 

Valuation of the company based on earnings per share (EPS), price to earnings ratio (P/E), and price to book value ratio (P/BV).

 

Comparison of P/E and P/BV ratios with the peer group of companies in the same industry to finally decide whether company is offering shares at an expensive price or not, whether there is a potential for any future price increase in the shares based on the current price that the company is offering or whether there is a possibility that these shares will fall as they are expensive and they will be available at a lower price after listing.

 

After analyzing all the above factors objectively and rationally, one can make a final judgment on the decision to buy or not to buy.

 

There may be some people who for reasons of lack of time, lack of effort and lack of knowledge are not able to analyze the above factors. They can scan the Internet websites of media companies or financial newspapers or investment magazines or contact few broking houses or investment banks and get a research report on the public issue.

 

Care should be taken to obtain and study research reports only from well established and reputed broking houses or investment banks.

 

Even then, it is always advisable that you take a long-term view of investing for at least a few years.

 

The final decision to buy or not to buy must be taken very objectively and carefully in light of all the financial facts available, as it is your own money that is at stake.

 

Happy Investing!

Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing.

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