Don’t Judge An IPO By Its Name

Initial public offering (IPO) is a buzzword on Dalal Street these days. A flurry of IPOs, from various new-age technology-driven and emerging sectors, have hit the capital markets recently. Most are drawing an overwhelming response from retail and institutional investors. Some have even got bumper listings on the stock exchanges. FSN E-commerce (Nykaa), which got listed on November 10, 2021, closed 96 per cent above the listing price. Other big names such as Paytm, PB Fintech (Policybazaar), Sigachi, Sapphire Foods (KFC and Pizza Hut) are in the listing pipeline. The much-awaited Life Insurance Corporation (LIC) IPO is also slated to hit the market soon.

The activity in the market is attracting investors towards IPOs. While they offer high growth opportunities, don’t throw caution to the wind. Remember, IPOs come with a fair share of risk, so you need to do due diligence before investing.

Here are the top four things to check before investing in them.

Go Through Draft Red-Herring Prospectus (DRHP)

DRHP is a prospectus that a company files with the market regulator, Securities and Exchange Board of India (Sebi), to take its approval before raising money from the public. This contains the complete biodata of the company and has information such as the area of operation, revenue, profitability, future plans about how the company is going to use the IPO proceeds, and so on. The DRHP will give you a complete picture of the company, so don’t forget to read it before subscribing to an IPO.

Check How IPO Proceeds Will Be Used

It is very important to check how the company will utilise the IPO proceeds. For instance, if the company plans to utilise the IPO proceeds to pay off debt, this will reduce the interest outflow but will not add to the company’s growth. However, if a company utilises the same for business expansion, it is a move towards growth.

Understand The Business

American investor Warren Buffett said it best: “Never invest in a business you cannot understand.” When the going is good, people often become reckless. Investors forget this piece of advice when there is a storm of optimism in the stock market. Invest only in the IPOs of those companies whose business model you can understand. Buffett, for example, has stayed out of the technology sector for the most part due to his lack of knowledge about the sector, he claims. It would be wise for you to give a miss to the IPOs of companies that have complex business models or the ones that you don’t understand.

Check Company’s Financial Health

Check whether the company is making a profit or not. Some big names that are actually loss-making, such as Paytm and PB Fintech (Policybazaar), have hit the stock market with IPOs but are getting good responses from investors. In such a scenario, you should look at whether the company’s loss is widening or reducing. It is always better to invest in companies making profits but future-looking businesses can also be a fair bet provided they are narrowing their losses.