Dalal Street was filled with chatter and excitement when food delivery app Zomato announced launching its IPO on 23rd July 2021. On day one of its opening, Zomato’s performance was impressive whose shares opened at Rs 116 on the NSE and closed at Rs 125.30. The listing price on the Bombay Stock Exchange was at Rs 115, and closed at Rs 125.85, up by 65.59 percent from its issue price.
Zomato’s listing in the exchanges will lay the stone of encouragement to several startups that will be keen to raise funds from the public and offer an exit to existing PE or VC funds or existing shareholders and promoters.
When a reputed company announces its IPO, it creates hype in the market that draws more and more investors to purchase. But, behind this expectation of higher returns and peer’s recommendation investors invest in IPOs in a hurry that results in investing in companies with no accurate research and analysis, thereby incurring massive financial losses.
So, what are the questions investors should be asking before investing in IPOs, and how can investors avoid potential risks?
Let’s take a detailed look at things you should keep in mind before investing in IPOs.
Things to keep in mind before investing in an IPO
Understand the business: Before beginning to invest, one must understand the nature of the business the company is in. The next step after understanding the business will be now to recognise the company’s growth opportunities and its capacity to capture the market share. An investor should avoid investing in IPOs if the business activities lack the clarity to an investor.
Recognise the risk: Risks are inevitable while trading. Understanding the risk associated with the company is an important factor that should be considered. The current market scenario, its competitors, quality of products and services, liabilities including the contingent ones should be thoroughly analysed to decode any potential risks associated with the company. Such details are available from the company prospectus.
Financial Health of the company: The financial health of the company should be assessed with its revenues and profits being consistent over the past few years. If the revenues and profits are showing an upward trajectory, then it is a green signal for investment. One should also check the valuations, since offer price can be undervalued, fairly valued, or overvalued depending on the industry parameters and profitability ratios.
Always read the DRHP: DRHP (Draft Red Herring Prospectus) is filed by a company to SEBI when it intends to raise funds from the company by selling shares of the investors. The prospectus elaborates how the company intends to use the money that will be raised, and the possible risks for investors. Thus, investors must go through the DRHP before investing in an IPO.
Study the strength and weaknesses: Investors can figure out the key positives of the company from the DRHP. One should try to find the company’s position in the industry in which it operates, it is positioning, and strategies. By reading this, one can find more about the company’s prospects.
The utilisation of the proceeds: An investor needs to check that how the funds from the IPO raised will be used. If the purpose of utilising the funds is to repay the debts, then the investment is not lucrative. But, if the purpose is to repay the debts and expand the business or utilise it for general corporate purposes then it shows that the funds will flow into the business making it a good share to invest.
Final word for investors
For investing in stocks, mutual funds, or IPO companies, investors first need to understand their financial goals. A wise investor should not make haste in investment decisions based on the market hype, publicity, and peer recommendation of someone else. Investors should do their research. If one can see future growth and potential in the company, then one should consider investing in its IPO.
