IPO: Look Before You Apply

In fact, investors must understand the basics. Investing in the IPO is more or less like an arranged marriage. And like the real marriage, here again, are five parties: In-laws – Promoters; Bride – Company; Brahmin– Book building bankers; Other relatives – Broker; Dowry – Retail discount.
IPO: Look Before You Apply
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Many people have started feeling that the IPO market (initial Public Offer) has become a lottery market nowadays. And some people have even opened more than one Demat account to apply for IPO. But it has always been like that since the number of market participants started increasing. Demand and supply will always play a role. However, the Primary Market is the backbone of the stock market. No denying the fact.

In fact, investors must understand the basics. Investing in the IPO is more or less like an arranged marriage. And like the real marriage, here again, are five parties: In-laws – Promoters; Bride – Company; Brahmin– Book building bankers; Other relatives – Broker; Dowry – Retail discount. As the in-laws know everything about the product they are on the sell-side and aware of the SWOT of the product. Investors are given a beautiful pitch by the Brahmin and given a day or two to observe the product. They will keep them motivated by all tricks in the trade. The deal is made sweeter by adding some dowry to it in the form of a Retail discount. The value of a product lies in the eyes of a buyer. For sellers, there is only one value proposition, which is to get the maximum price. The buyer has to find if they need the product or not.

So an investor must keep in mind the following points before applying for an IPO

A company starts with a Promoter’s vision. There may be some angel investors on board in the beginning. Most of these angels are known to promoters. They believe in a binary investing style. Either company works to 10x or dies down eating their money. Next in the chain is the VC fund. These are intelligent institutional investors who are convinced of the business model, promoter’s execution skill, and want 25% + equity with the smallest of the capital invested. They want to make 10-100x from thereon. Then comes Private equity who wants to board the fastest moving train which can take it to the destination in the shortest possible time. If the Promoter is selling shares, go ahead. If PE is selling its shares, then wait for the euphoria to settle.

If the promoter is selling his shares only to make money, then let it pass. If he is selling with a reasonable valuation, keeping a 51% stake, and wants some money to grow business, then look into the company. If the promoter is GOI, then it brings discipline among management to perform. The main purpose of an IPO is to raise capital from the public, but at times the motives have been bad.

Look for the past history of the middle man. The middleman’s only interest is to get its cut. If the share price rises too fast, the sell-side abuses him. If it falls after listing, the buy-side abuses him. So look for a credible middle man. If an issue is small and the middle man is unknown, how beautiful company it may be, you will be better off not buying it.

Value promoters who can price shares at a premium as it shows he is confident. If he is around, he will make money. High-priced IPO with good fundamental business history and execution rises only. Also, watch out – Is this company a leader or yet another entrant in this business? If it is a leader and commands a 30% market share in the industry, go ahead. If the promoter and management are the same, prefer to go to a guy who has rich experience of execution and is mostly the first generation in the business. The first-generation entrepreneur has everything to achieve. The second generation mostly gets ready-made business with lots of easy money. The third generation gets everything and has only purpose to grow it bigger and better than previous generations. If you find business is bad, but management is capable then go for it. A good manager will find out how to run a bad business profitable. A good business, but mediocre management will test your patience.

Who are the buyers – QIB, HNI, or retail. Why are they buying? QIBs will buy keeping in mind the stock position in the index. If the stock is going to be part of any index, they would like to buy so that they can beat the index. They also buy to help the middle man. Middleman gives them the best deal in an allotment. HNI is a breed that is just looking to get a return on its leveraged money. They will mostly be attracted to small-size issues. An operator is born from this class of investors.

And also the finer points

  1. Knowing the status of the sector is also important. Has this sector been in huge demand? If the market is too euphoric about an IPO, skip it. When everyone follows the same strategy to make money, no one makes money.
  2. Many investors are interested in retail discounts. However, history suggests that don’t fall prey to this. The market will price it such that you will get only a discount as a return.
  3. Remember if the size of the IPO is too big, you need to read more since it is going to stay in your portfolio for long, you like it or not.
  4. If the company has been paying dividends, check if you are buying a mature business or promoter has taken all the money from the company to his kitty. Avoid huge dividend-paying companies. If the promoter has taken all the money generated by a business, he has got his return.
  5. If in a bullish market IPO is coming, then be skeptical. If the market is bearish and IPO is coming, read it. It will give birth to a multi-bagger in your portfolio.
  6. And as the question of expectation is concerned for the nightstand, it should be ultra-good. More than 40-50%. For portfolio return, it should be more than 18%.
  7. Promoter shareholding post listing – it should not be less than 50%. If it is less, it has to be a very mature business.
  8. If you find a company performing too well for the last three years don’t buy in the IPO. Buy after 2 – 3 years. Why? Most companies keep in mind the timeframe when they would like to list. They start preparing and will outperform on all financial aspects to the best possible margin. Now, once it gets listed, they lose the steam and go into hibernation. It is a tired feeling after a sprint. Avoid such companies.
  9. Watch cashflow, ROE, ROCE. Look into these numbers with a pinch of salt. If it is too good to believe. Don’t believe it.
  10. If a company is less than 5 years old, find out sales growth. If sales growth is 40% plus, see if it can sustain this. If yes, sell your house and buy this company, if you are convinced on all other aspects. If a company is a decade old, consistent sales growth is 20% plus, look for EBIDTA, PAT, CFO, and CAPEX plan. If things look fine, read further. If the company is more than a decade old, the IPO size has to be big enough to read.
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About the author: IE&M Team
IE&M Team
Indian Economy & Market is an Indian media and information platform producing data-backed news and analysis on all the vital elements at the intersection of the economy, stock markets, mutual fund, insurance, commodities, currency, technology, startups and business.

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