Tuesday, July 20, 2010

Should you Invest in IPOs - Investment in IPOs part 2

Welcome back to the ABCs of investing in IPOs. So how do investors protect themselves and take advantage of the IPO opportunities?

● Do check the quality of the promoters before investing in the stocks. What is their track record? Are the promoters/management trustworthy? Did their other group companies that have earlier gone for IPO provide adequate returns to investors? At what price did the promoters and other investors invest in the company? What would be the promoter stake post the public issue? Whether they have any strategic/technical tie-ups or alliances with well-known companies etc.
● Do check the basic valuation metrics such as EPS, P/E, Book Value, Dividend yield etc. Has the company been able to increase its revenues and profitability over a period of time? What is the valuation of the company when compared to its industry peers?
● Do check, where would the company utilize the IPO proceeds and how would the company benefit by going for an IPO?
● Do check the future prospects of the company and whether the company can grow its revenues and profits, going forward.
● Do check the IPO grading: Before the issue, the issuing company needs to get itself graded by the credit rating agencies registered with SEBI. The grade represents a relative assessment of safety, return, risk of IPO vis-à-vis other listed equity shares. The higher the grade the better it is, though a higher grading would not guarantee any returns to investors, if the issue were expensive.

● Do not invest in the IPO just because everyone else is doing it and you would not like to miss the opportunity. Remember that if more number of people applying (i.e. the demand is high) the price is usually not cheap and the possibility of making return post listing would also diminish.
● Do not invest in IPO with the hope of making instant return (especially if the IPO is expensive), because the ‘grey market (unofficial price)’ premium is high. This grey market premium is usually manipulated and it could (and most likely it will) change before the listing and the investors hoping to make a quick profit could end up making a loss.
● Do not invest because the current IPO is relatively cheaper than the listed stocks in the same space, if on absolute basis the stocks in the industry are expensive.
● Do not invest if there are significant risks in the horizon especially where there are execution risks, compliance risks, contingent or regulatory risks. As any developments on these fronts can risk the value of the investments in the company.
● Do not invest in IPOs if one is not ready to take the risks associated with investing in equity shares.
While the current regulations are tighter than in the past, and have resulted in the improvement in the quality of promoters that are accessing the capital markets to raise funds, investors need to be alert to the hype surrounding the IPO issues and focus more on the downside risks and potential returns based on the company’s valuation.

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