What to look at when Investing in an Equity IPO.

What to look at when Investing in an Equity IPO.

Take a view on the market

The equity market decides the price of a stock and fundamentals in the short-term play only a 30-40% part in the valuation of a stock. If markets are on a sharp uptrend in the recent past and the rally looks suspect, one could avoid a IPO, however good it may be. The listing price depends on the market when the stock lists and not the market today.

Research the stock

Adequate research is, without a doubt, the most effective way to identify and stay away from the IPO disasters waiting to happen. The prospectus, which contains nearly all aspects of a company's business and game plan, is the first place any investor interested in purchasing a new issue should look.

Getting a prospectus is easy. If you're reading this online, you should be able to electronically download a prospectus without any problem. Prospectuses for all Indian companies are available for free from the Securities and Exchange Board of India's Web site, www.sebi.gov.in. A abridged portion of the prospectus is also available with the form.

Companies have to be completely honest about all of their warts in order to avoid future lawsuits. Thus, bullish statements are often followed by cautionary disclaimers, and there's an entire section titled "Risk Factors" dedicated to what may go wrong at the company. Before you get scared off from investing in an IPO, however, you should realize that many of these risk factors and disclaimers are included in every prospectus. Litigations, key patent challenges and indebtedness are risks that should not be ignored.

Following is a list of some warning signs that prospective IPO investors should pay close attention to. In general, they're listed in order of where one would find them in the prospectus, from the front of the document to the end.

Investment Banker:

A well known name helps. 

Business and Strategy:

This is contained in the summary portion of the offer document. A key factor to consider is the attractiveness of the industry that the company operates in. A company in a growth sector in which there are few listed stocks is attractive if at the right price. Competition and small market share in a fiercely competitive sector is a negative for the company. Also, over-reliance on a few and large customers is a danger as these customers can switch or put pressure on margins and hence earnings. 

Financials:

Look at summary financials especially book value, earnings per share, dividend payment track-record, debt to equity. Also, check for declining revenues or margins. High working capital is a negative signal. 

Promoters Holding & Equity History:

A background check on the promoters and history of other group companies is very helpful. Also, one needs to look for any issue of shares to promoters in the last one-year and the price of the issue.  Objects of the issue:

Is the money for the use of the company or is the promoter offloading his/her share. If the money goes to the company it helps the shareholders in the form of future growth. If the object of the issue is to fund working capital, avoid the issue. Ditto for repayment of loans. 

Valuations:

Comparision of P/E, P/BV and dividend yield with other companies in the industry helps. Data on competitors is available in a prospectus or can be obtained from sites of exchanges - www.bseindia.com or www.nseindia.com. Valuations hold the key. Sometimes not much is left on the table for investors, especially if the promoter is trying to offload his/her share.

Look at demand

A good IPO will have huge amount of over-subscribtions. Allocations could vary from zero to very low. Hence, while one could make phenomenal profits on the allocation, one may not make a decent return on one's investment.

Above all one must remember that the investment in equities and equities are risky - one must be ready to loose money.