What is an IPO?
IPO means initial public offering. Through IPO, companies sell their shares for the first time to raise funds from retail investors. It is through IPO that a company becomes publicly listed from private. If you have a good understanding of the market and understand the fundamentals of a company, you can make good money through IPO. Investing in an IPO can be a wise move for an experienced and knowledgeable investor. But it is not necessary that every new IPO will be a good opportunity to earn money. Profit and risk are always involved. Before investing in IPO, one should have basic information about IPO.
What is IPO in Indian stock market?
Before understanding IPO, let’s know its full name, which is Initial Public Offering, which we call IPO. Another definition of IPO could be that through IPO, a private company becomes a public listed company for the first time by selling a portion of its shareholding to retail investors.
The main objectives of IPO are to inject new funds into the company, facilitate trading of the company’s existing assets, raise funds for future projects, and monetize the money of the remaining investors.
Details related to allotment of shares to HNIs (High net worth individuals), Institutional and retail public can be seen in the prospectus. Prospectus is a detailed document which comes after SEBI approval, which contains all the offering details.
After the IPO, the company’s shares are listed and can be traded (bought and sold) in the open stock market. The minimum free float on shares is determined by the stock exchanges, which is in full and in proportion to the total share capital.
Types of IPOs Explained
There are two types of IPOs, which are listed below.
Fixed Price Issue
In this issue, the company and underwriters analyze their liabilities, assets, and all other financial data. They then set a price to achieve the desired capital, or IPO issue size. The price is justified by examining the quantitative and qualitative aspects of the order document. Demand for the securities is determined only after the issue closes. IPOs often reach oversubscription levels.
Book Building Issue
In this issue, the price is determined during the IPO. There is no fixed price, but rather a price band, i.e., a price range. The minimum price in this price band is called the floor price, and the maximum price is called the cap price. Investors can bid for the quantity of shares they prefer. The price of the shares is determined based on demand based on these bids, and the securities are offered at the floor price or above. Daily demand for this issue is tracked, which can be seen in the gray market premium.
In the fixed price issue method, it is believed that the company’s shares may fetch a lower price, because most of the times the price is lower than the market price. Due to which, more shares are sold and investors increase the value (market capitalization) of the company. According to the book building method, fixed price issue gives high efficiency, because it balances the price of shares according to demand and supply, companies get the right return and investors also get profitable returns, because price fixing happens after IPO closing.
What are the benefits of IPO investing ?
IPO investors can purchase shares of promising companies with future growth at an offering price before public trading begins. If the company’s business grows well, early investors can earn listing gains and long-term capital appreciation and dividends.
High Returns Potential: If you thoroughly analyze a company with strong fundamentals and invest in an IPO while keeping future growth in mind, you can get good returns along with business growth.
Portfolio Diversification: Through IPOs, we can invest in new sectors and emerging businesses, allowing investors to diversify their portfolios and earn multi-bagger returns.
What are the disadvantages of investing in IPOs?
Volatility on Listing Day:
Market sentiment, supply-demand, and broader stock market conditions can cause high share price volatility on listing day. The opening price of an IPO may be higher or lower than the closing price.
Lack of Historical Performance:
Unlike established companies, publicly available data about newly listed companies is very less or limited. This makes it difficult to predict company’s future, long-term performance of company, and stability in market.
Risk of Overvaluation:
Some IPOs are launched aggressively at a fixed price to raise more capital. If a company’s IPO price exceeds its intrinsic value, the share price may decline during post-listing stock market adjustments.
What is OFS ? ( Understanding Offer for Sale in IPO. )
OFS provides exit to the promoters or early investors of the company. Through this method, existing shareholders can earn profit by selling their shareholding in the primary market at the time of IPO. In offer for sale, there is no fresh issue of equity i.e. new shares, only early investors sell their company shares.
Whereas, some companies also offer some part of fresh issue of equity in the same IPO to provide exit to promoters or early investors from the company.
How to analyze IPO before investing?
Before applying for an IPO, it’s important to examine certain market factors to analyze the IPO.
Follow the following framework to evaluate IPO opportunities:
Company Fundamentals:
While analyzing the prospectus of company, carefully analyze company’s financial statements, company revenue, profitability growth, debt levels, and cash flow patterns. Compare these factors to peer companies.
Industry Outlook:
Must analyze the growth potential and competitive landscape of the sector. Those businesses whose Development and Future policy is strong and supported by Government policies, those companies will perform better in the long-term.
Use of IPO Proceeds:
Companies clearly state in their prospectuses where and how they plan to use the funds raised from the IPO. In an agricultural fund, if the funds are used for future projects or research purposes, it reflects the company’s future planning. In an agricultural fund, if the funds are used solely for debt repayment or for the exit of promoters, caution should be exercised here.
