IPOs have always been popular among retail investors. The recent Burger King IPO listed at a whopping 130.67% up. Similarly, Mrs Bector’s IPO listed at 106.79% up!
Such high gains have made retail investors assume that investing in IPOs will lead to guaranteed returns.
While investing in fundamentally strong companies will lead to gains, not all IPO investments are successful. For example: SBI Cards & Payments Services Ltd listed at -9.51%.
To help you decide which IPOs are worth your time and money, today we will reveal the top 10 tips and strategies of investing in IPOs.
But before that, let us quickly understand what is the meaning of IPO.
Meaning of IPO
An Initial Public Offering is when a private company sells its shares to raise money for the first time. Post an IPO, the company’s shares are listed on the stock exchange and are available for trading.
To get an in-depth view on IPO investments, read our article on basics of IPO investing.
10 Tips & Strategies of Investing in IPOs
IPO Investment Tip 1: Do Your Own Research
When you invest in IPOs, you are investing in private companies. Private companies do not have strict disclosure norms. So, often companies can hide sensitive information from the general public.
Even when so-called ‘experts’ review IPOs, they only look at publicly available information. They do not conduct in-depth research into a company’s financials or internal workings.
The red herring prospectus does give a good picture of the company and is also approved by SEBI. But remember, the red herring prospectus is written by the company itself and the company will try to hide all negative information to maintain its reputation.
So, before you invest in an IPO, conduct your own research and do not rely on third party. You should ideally, compare the company’s performance against its peers, overall sector analysis and its future growth projections.
IPO Investment Tip 2: Read the Red Herring Prospectus
An important IPO investing tip is to put efforts into studying the red herring prospectus. When you invest in an IPO, you become an equity holder of the company. So, unlike debt investors, you do not have any safety of capital.
Therefore, it is important for you to read the red herring prospectus in detail to understand how your money will be invested. You can get the red herring prospectus from:
- Company’s website
- Stock Exchange website
- SEBI website
- Newspapers & Magazines.
The red herring prospectus will help you understand:
- Background of the company
- Details of the promoters
- Reasons for going public
- Risks involved in the company
- What the company plans to do with the money etc.
A red herring prospectus is a crucial document for you to review before investing in IPOs.
IPO Investment Tip 3: Know Where your Funds are Invested
A red herring prospectus only tells you how your funds are utilised. But knowing this is important. If the company is raising funds to repay its liabilities, then it is not a positive signal.
But if a company is raising capital for expansion and research, then that IPO investment can be worth your time and effort.
IPO Investment Tip 4: Probe the Promoters & Management
Often IPOs are an exit-window for the promoters. Hence before you invest in IPO, do a background check on the promoters and their experience with the company. Also, pay special attention to the company’s management.
Smart investors like Vijay Kedia, Charlie Munger pay special attention to a company’s management.
Quality of management differentiates a high growth company from a poor growth company. A responsible management team can manage a company through temporary crises and create wealth for investors.
So, an important IPO investment tip is to invest in companies with strong management.
IPO Investment Tip 5: Invest in IPOs Backed by Strong Brokers
IPOs are managed by brokers. While there is no rule that big brokers won’t underwrite poor companies, it usually doesn’t happen. Big brokers have their reputation to care for and hence will underwrite IPOs of fundamentally strong companies only.
But simply because the broker is a big name, doesn’t mean you should invest in every IPO underwritten by the broker.
For example: The Hathway Cable & Datacom IPO was underwritten by Kotak Mahindra Capital & Morgan Stanley. The IPO’s listing gains were -82.68%!
But similarly, small brokers can be easily bought and may underwrite poor IPOs as well. So, when investing in IPOs, invest in one backed by a strong reputed broker.
IPO Investment Tip 6: Invest at Cutoff Price
IPO Investment is considered to be a game of luck. When you invest in IPOs, you have to bid on a price within the price band specified by the company. To ensure you get the allotment, then you should bid at the cutoff price. This way, at least your application will be considered irrespective of the final allotment price.
IPO Investment Tip 7: Valuations Matter
It is difficult for retail investors to find out the correct valuations of a private company. While underwriters and investment bankers try to evaluate the valuations based on management and returns, you should also set up valuation benchmarks to judge the company against its peers.
IPO Investment Tip 8: Plan an Exit Strategy
This is an important IPO investing tip for short-term investors. You should decide at which levels you will sell your shares and book your profits.
Usually, shares of good companies list at high levels and then drop over the course of a few months. So, if you are a short term investor and want to exit in a couple of days (known as flipping) then you should pre-decide your exit levels.
Alternately, you should also decide your loss levels, as all IPO investments might not work in your favour. So, setting up a stop-loss and book profit is very important while investing in IPOs.
IPO Investment Tip 9: Understand the Lock-in Period
This IPO investment tip is really important for retail investors. Underwriters and insiders have a legal contract for holding shares.
If the underwriter starts selling shares after the lock-in period then the share prices will fall. This means that the brokers are not confident of the company’s future prospects.
Similarly, if the underwriters hold the shares even after the lock-in period, then it is a good indication as it shows trust in the company’s future prospects.
IPO Investment Tip 10: Be Skeptical
IPO investments are considered to be safe. But this is far from the truth. Since limited information is available, investors rely on broker’s advice for investing in IPOs. Often brokers target high net worth individuals and institutions for investing in IPOs. So, if your broker recommends you an IPO, then be skeptical as it may be because HNIs and institutional investors do not want to invest in that particular IPO and the broker is ‘recommending’ you just to make a sale.
IPOs are a great method for companies to raise equity capital. But not all companies raise capital for the right reasons. Some might raise funds to simply pay off its liabilities. So, your hard earned money is used to pay someone’s debt, not for growth.
Therefore, it is important to carefully analyse the hidden information of these private companies before investing in IPOs. Apart from resources and a keen eye, you also need an unbiased broker like Samco to research and recommend good IPOs for investments.
In addition to IPO research, Samco also provides a robust trading platform through which you can apply for IPOs without any paperwork or hassles.
With upcoming IPOs of IRFC, Hinduja Leyland Finance, Lodha developers etc, open a Samco Demat and trading account today and invest in the best IPOs of 2021.