An Initial Public Offering (IPO) is when a private company lists its shares on the market for investors to buy and sell for the first time, converting it from a private company, to a public one. For companies, there are a number of reasons as to why they would choose to ‘go public’, with the most common reason being in order to raise funds to fund business or operations, expansions etc. Let’s understand how an IPO works and how a company can offer IPO shares.
When an entrepreneur starts a company, they look to raise funds. Usually, in the early days of the company, these funds come from friends and family and then eventually from early stage seed funders, Venture capital firms and other larger Private Equity firms in subsequent funding rounds. This makes all these investors shareholders in the company. Once the company grows in size however, it might need a significant corpus of funding to rapidly expand or even to just provide its investors with a sizable exit. If the company feels like it is up to the challenge of making it through SEBI guidelines, it can turn to the public to raise funds, by offering them the opportunity to buy the company’s shares on the stock market.
For you as an investor, this means an additional investing opportunity, an attempt to get in early, and the potential for significant gains in the long run Given that there are a number of IPOs coming up this year, this article will break down how an ipo investment works, how you can pick a good IPO to invest, and some tips on buying and selling IPO shares.
How to pick a good IPO
As with most other things in the stock market, there exists no hard and fast rule to calculate whether an IPO is good or bad. While investors can read certain technicals and fundamentals about the company that might be indicators of how an IPO investment is going to perform, the performance of the IPO is most likely dependent on the investors in the stock market they are looking to raise funds from. Given that most investors follow similar technical and fundamental assessment criteria, it is possible to gauge how a stock will perform and if it is a good IPO to invest, based on its technicals and fundamentals.
Here are some things you can look for while trying to identify a good IPO investment.
1. Understand the business model.
While it is to some extent possible to predict how a stock will perform in the short term and mid-term durations, assessing whether a stock is a good IPO to invest in for the long run is pertinent on the company’s core business model, in the long run, the stock price will depend on how the company performs. This also explains while certain steel, coal and oil companies have been considered stable investments for decades; due to the stability of the underlying business.
While aiming to truly understand a company’s business and assess whether it is a good IPO to invest in with strong IPO shares, investors could look into the promoter and shareholders of the company, how credible they are, their qualifications etc. One of the reasons for this stands to be that these factors are indicators of how the company will perform in the long run, after its IPO buzz dies down.
2. Understand the risk from the market’s perspective.
As has been mentioned before in the article, doing your research on the company and understanding its business model is a good way to assess the quality of an IPO. However, chances are that if, as an investor, you are looking at these factors and pieces of information, then it is likely that other investors interested in the IPO are doing the same as well. Understanding the IPO shares not only from your perspective, but from the market’s perspective can help assess what a good IPO to invest in is, and how it might perform in the long run.
3. Investor and promoter holdings.
According to regulations, any company offering IPO shares in the market has to have their promoters have a post-issue stake of 20%. The ownership of a company’s shares by its promoters and investors is a good indicator to tell how a company might perform. Here, instead of doing the research to assess whether you think the company is offering good IPO shares, you outsource this work to the promoter and investors of the company. Generally, if promoters and investors hold a larger percentage of the company shares, this is a good indicator as it means that they are confident about the company’s prospects.
4. Growth potential.
While you are investing in stocks in the short run, you are likely to look at how the stock price of the company has been performing. While looking for an IPO investment, however, one could look at how the company is and is likely to perform. For IPOs, picking a company that offers a service that is unique and is likely to succeed in the future, might prove to be beneficial, landing you with a good IPO to invest in.
There exist a number of other assessment criteria that you should study thoroughly while picking an IPO investment before you make your purchase. While on one hand, there are a number of factors that make up a good IPO to invest in, you should also look at whether that IPO is a good investment for you specifically. This can be done by laying out your goals. The IPO investments you make will vary based on factors such as your timeframe. If you are looking to flip your investment in a short period of time for a quick profit, then your IPO investment of choice might vary from someone who is looking to hold the IPO for a longer term.