Stock markets 101: A five-step guide to IPO investing

Holding shares in an IPO listing is a commitment that often warrants a leap of faith, however, making an informed choice while applying is not entirely impossible. How, you ask? Expert tips.
Representational Image. (Express Illustrations | Amit Bandre)
Representational Image. (Express Illustrations | Amit Bandre)

It has been raining IPOs (Initial Public Offerings) in India. 

Between January and September 2021, USD 9.7 billion was raised in IPOs by as many as 72 Indian companies, a figure that has been touted as the highest in two decades. The 2021 IPO boom witnessed debuts by several Indian unicorn startups, kicked off by Zomato's remarkable IPO.

Zomato's IPO got subscribed 38 times, Paras Defense 304 times, Tatva Chintan Pharma 180 times and Rolex Ring 180 times. Nykaa's IPO went on to make Falguni Nayar India's first self-made woman billionaire. And May 2022 has now seen the mega LIC IPO.

While some of the frenzy was partly because of the bull run that the equity markets had seen, it was also because of the inherent ways in which the IPO allocation and funding process work, as one of our editorials noted.  Even the RBI seemed to be worried about the 'unhealthy' practice of creating hysteria around an IPO, it went on to add.

Holding shares in an IPO listing is a commitment that often warrants a leap of faith, however, making an informed choice without falling prey to the hype surrounding it when you are applying is not entirely impossible. How, you ask? The pointers below might help. 

1. Understand the business and business model

When it comes to deciding whether to subscribe to a company's initial public offering, experts believe that knowing the company, its business model, and performance record is what an investor must place emphasis on. 

"Unless one understands the business and the potential of making money from that business, an investor will not be able to fully grasp the ethos of that IPO," said Vivek Bajaj, CA, and co-founder of Elearnmarkets and StockEdge. In this regard, the red herring prospectus issued by the company at the beginning of the IPO can come in handy. It contains details of the business model, areas of potential growth, a report on its financial health, and other information that can assist an investor in building their conviction towards putting their money in the company.

2. Where is the IPO money going?

According to Bajaj, the intended use of the raised funds can be a tell-tale sign of the overall robustness of the company at the moment. "Will the money raised in the IPO fuel future growth or will it be used to offer an exit to existing investors? The latter is always a red flag," he said, adding that in such cases, most of the money is taken away by the early investors, leaving little for anything else. The details on the purpose of the IPO are chalked out in the red herring prospectus itself. A company that plans to use the funds for growth, expansion, acquisitions or new tech is thus often a more desirable bet for investors than one that will use the proceeds to settle debts or provide an exit route for early stakeholders.

3. Is the IPO overvalued?

It is not easy for retail investors to always understand whether a company will get listed at a premium on the IPO price band. One of the ways to check if the IPO price is overvalued is to compare it to the shares of its peer companies. "For new generation companies it is very difficult to give a valuation benchmark," Bajaj said. "But for traditional businesses, judging the price band can be possible by finding out their relative valuation." 

He cited an example of a restaurant or hospitality business coming up with its IPO. According to him, in such a case, an investor can check what multiples other listed hospitality and restaurant businesses are trading at, and compare those with the multiples of the IPO. 

"It is easier for the selective class of investors who understand new generation businesses like Zomato and Paytm to have conviction in such IPOs," Bajaj said, adding a key piece of advice, "People who cannot understand the business models and future business potential of such new-generation companies should not apply to their IPOs."

4. Check Grey Market Premium and subscription by Qualified Institutional Buyers

"One of the ways one can judge if it's possible for an IPO to be successful is by looking at the Grey Market Premium that is disclosed on the internet or on TV prior," Bajaj said. 

For the uninitiated, Grey Market Premium (GMP) denotes the price at which shares of the company coming out with the IPO is being traded in the grey market. The GMP thus indicates the premium at which retail investors are willing to buy its shares, and often acts as a litmus test of whether the IPO will be successful and what the listing gains might look like. He adds the quantum of oversubscription by Qualified Institutional Buyers (QIBs) as another important benchmark while judging an IPO. 

"If institutions are oversubscribing and there are good quality anchor investors associated with the IPO, then the chances of it succeeding is quite high," Bajaj underlined.

5. Avoid hype and FOMO

Popular bullish sentiment among investors often find word-of-mouth channels and trump more rational factors when it comes to swaying people. But experts don't consider that a good approach to putting one's money, especially in the primary market. 

"Your neighbour or a dear one applying to a certain IPO should not be the only reason you choose to subscribe to the given IPO. One should avoid the herd mentality that usually comes with a bull market like the one right now," Bajaj said, highlighting how FOMO (a popular acronym for the 'fear of missing out') has emerged as a strong driving force in investing decisions, or regret thereafter. 

Finally, as one expert pointed out, invest in IPOs only if you want to benefit from listing gains. For the rest, there is the secondary market.

You applied for the IPO but did not get an allotment. What next?

According to Bajaj, if one does not get the allotment to a company's IPO whose shares they were keen on holding for the long term, the best way to invest in it post-listing is by SIP, i.e buying its shares at regular intervals over a long period of time. "In such cases, you can't judge whether a particular price is expensive or cheap for such shares, so this method can average out the costing. For retail, SIP is the best way - one should not enter the market at one particular price," he said.

IPOs to look out for in 2022: LIC (May 4 to May 9), Delhivery, National Stock Exchange, Ola Cabs, MobiKwik, PharmEasy, OYO Rooms

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