How to choose the right IPO?

In this article, we will cover the key factors to be considered before investing in IPOs, how to find such information regarding these factors, the best and worst-performing IPOs, and upcoming IPOs.

· 4 min read
How to choose the right IPO?

2021 was a fantastic year for the Indian capital markets, with the indices touching new all-time highs every day and a record number of unicorns India has ever produced. This generational bull run has worked its magic on IPOs as well, with the best 5 IPOs returning over 100% each inside a year. However, one must also note that the worst IPO in this duration destroyed 50% of investor wealth in a snap. Therefore, research needs to be done before IPO investing to improve your odds of successful listing gains and further growth.

In this article, we will cover the key factors to be considered before investing in IPOs, how to find such information regarding these factors, the best and worst-performing IPOs, and upcoming IPOs.

Factors to consider before investing in an IPO

A) Financials of the company

You should be thorough with the financials of the company’s previous 3-4 years before looking to invest in it. This requires you to go through their cash flow statements, sales growth, revenue growth, debt levels, etc., and whether there is a consistent and predictable year-on-year growth. It shows whether the company is delivering consistent growth in its financials.

B) Market share

It is crucial for newly IPO’d companies to have a high market share in their industry i.e. how much of the customers in the market are being served by this company. You will also have to verify whether they have been growing their market shares over a long time. For example -  a recently public company like Zomato had a market share of over 70% in the food delivery business before its IPO.

C) Market disruption

The company of your choice must be breaking barriers, coming up with innovations to revolutionize the industry for it to have a better chance of being a successful IPO. Companies like Zomato, CRED,  Ola, Oyo, etc., have completely changed the way people go about with their business.

D) Debt and Equity Valuation

The levels of debt that a company has, along with the repayment strategy can make or break the future of the company in the long term. Many billion-dollar companies have had to shut down due to debt, despite once being in comfortable positions.

Adding to the debt amounts, you must ensure that the company is valued as precisely as possible with respect to industry competitors and its own financials. Overvalued companies tend to tank eventually, sometimes regardless of actual financial performances.

If you find that the debt levels or valuations are unusually high, think twice before investing in the IPO.

E) Economic moats

Legendary investor Warren Buffett once claimed that he does not invest in any company without a moat. The ability to create and maintain a competitive advantage over the competitors is a massive plus point and could be the difference between a market leader and just another competitor in the market. Companies like Asian Paints, Bajaj Finance, Page Industries, and Eicher Motors in the Indian markets have made economic moats that allow them to remain as leaders in their industries for a long period of time.

F) Legacy issues and Corporate Governance

If there are any serious legal cases that could impact the survival of the company, you should be cautious before investing in it. Also, ensure that the promoters and owners have a solid and consistent track record of good corporate governance before investing in the company.

Sources to find relevant information

There are two major sources to find all the relevant information regarding the company that’s about to go public:

A) DRHP

The Draft Red Herring Prospectus (DRHP) of the company has all the detailed and required information on the factors listed above, that can help you take a stance before an IPO.

B) External Research reports

While the vast information released in the DRHP is required for institutional investors, it may overwhelm the retail investor. Therefore, you can alternatively choose to rely on research reports by broking firms and related institutions, which use the DRHP as the base to make a relatively concise research report.

Actions after investing in the IPO

Once you have done your due diligence, read up all the factors affecting the IPO, (hopefully) got an allotment and bought the stocks of the newly listed company, the next steps will depend on the company and its performance in the market. If you have applied for the IPO only for the listing gains (which is not recommended) then you can exit the position as soon as you have received your gains. However, once you have done so much research, it is ideal to stick with the company for the long run. Many billion-dollar companies have started off with both average as well as spectacular IPOs (for example, Infosys and Reliance Industries respectively) so don't judge the success of the investment from just the IPO returns.

Performance of IPOs in 2021

While many companies have had successful IPOs over the course of 2021, some of them flopped disastrously, causing massive investor wealth loss. Companies like Nureca Ltd. and MCAR Technologies saw over 60% in listing gains alone, while the likes of Kalyan Jewellers and IRFC disappointed in their IPOs.

Upcoming IPOs in 2021

There are many exciting IPOs that are expected to take the Indian equity market by storm in the upcoming months, and we recommend you to use the knowledge from this article to make your first solid IPO investment. All the best!

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