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Initial Public Offerings (IPO)

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What Are The Factors Considered For Investing In New Issues?

Factors Considered for Investing in New Issues

There are major factors to be considered for investing in a new issue. They are:

  • Understand Sectors and sectoral sentiments: It is essential to understand the sector in which the company operates. We should ask the question: How is the sector currently performing in the economy? If we analyze the sector is performing well, then there is a possibility the IPO will be a success.
  • Plan Investment horizon: It is essential for all investors who are applying for the IPO to decide their investment horizon. It can be either held for listing gain or may hold for a long-term horizon.
  • Study Red Herring Prospectus (RHP): This document is handy to investors as it contains all information related to the company's business operations, financials, and promoters details. It also offers how the company is going to use the money raised through IPO.
  • Valuations: The IPO valuations are normally done as per the demand and supply of shares in the traded market. To figure out appropriate IPO valuations, company leaders, investment banks analyze the health and performance of the company.
  • Read Brokerage reports: It is very important for every investor to read reports of different brokerage firms to get an idea of how various financial analysts are taking their calls to subscribe to the IPO or not subscribe.
  • Grey market premium: A grey market is an unlisted marketplace where participants buy and sell applications among themselves in exchange for money. It is unorganized and not regulated by any regulatory body. It is usually the case that the higher the grey market premium, the higher the possibility of listing gains.        

What are the risks and concerns involved in investing in an IPO?

Investing in an IPO is risky. There are many risks and concerns involved in applying for an IPO and some of them are:

1. There is no guarantee of share allotment. In the case of oversubscription, the shares are allotted on proportionate basis. At times, it gets extremely difficult to get an allotment.

2. Investor's money also gets locked for some time.

3. The benefit of share allotment in case of oversubscription is marginal to retail investors as they can get only a single lot of shares.

4. After listing, shares may quote at a lower price than the IPO offering price due to change in market sentiments. Investing based on GMPs is never a good idea as they are prone to volatility and manipulation.

What are the risks and concerns of an IPO from the company's perspective?

There are several disadvantages of IPO to a Company as listed below.

  • Expensive: There is a significant accounting, legal & marketing cost involved in an IPO.
  • Reporting Responsibilities: It is required for a company to disclose several financial and business information. Companies may misuse competitors, suppliers and customers information.
  • Funding risk: The expected funding from the IPO may not be raised.
  • Loss of control: Ownership is transferred to the new shareholders.   

IPO investors can be divided into the two:

1) Traders looking for short-term gains- usually exit after a quick pop on the day of listing. Bull markets are a breeding ground for such types of market participants since listing gains can be quite significant in such an environment.

2) Investors with a long-term view- IPOs are best suited for long-term investors since they can own a chunk of the company at a favorable price(since IPOs are generally underpriced). In many instances, quality companies have quadrupled in value in a few years of their listing.

Note: We have covered all the major learning areas related to IPO in India. Yet, we have a special section called 'ELM Special Gyan.' in the next unit so that you can get the best out of this module and succeed in IPO investing. 

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