With so many issues hitting the market, we thought it’s the right time to publish a guide to investing through IPOs for starters. This guide will help you to understand questions like – What is an IPO, How to evaluate an Issue, How to invest in IPOs
What is an IPO and why does a company need it?
IPO stands for Initial Public Offering. As the name suggests, the equity of a company is offered to the public at a price for the first time. This first offer/sale of stock to public is also known as trading in the Primary market. Once the Stock lists on exchanges and starts trading it becomes a secondary market trade.
When a company wants to expand it has the following choices-
- Loan from Banks (This comes at a high interest rate which adds on the debt/liability on the company)
- Private Equity (Not ideal for raising huge amount of cash. Makes the company dependant on one/few individuals)
- Initial Public Offering (Ideal for raising huge cash in exchange for a part of the company’s equity. No liability of interest or dependence on few investors)
For a company to come out with a Public offer it should usually have good past record of incremental profit and revenues. The company files the Red Herring Prospectus having all financial details to the Securities Board. (In India, it is SEBI)
The face value of a stock is fixed at Rs 10. The Price band is the price range at which the company offers it’s shares. Post listing the dividend declaration, Bonus Issue or Share split is done based on the Face value of the share.
How to evaluate an IPO?
As discussed above, the Red herring Prospectus is the document which will give you all the information you need to known about an IPO. But, it is usually a huge document and not very easy to completely comprehend. J
This document has to be compulsorily made available on the website of NSE by any company going public.
Some other ways of evaluating issues are by understanding the business of the company, Checking the profit/ revenue figures of the company, Calculating the Price to Earnings ratio. These are explained in detail below-
Understanding the business of the company: Do the due diligence on the Issue you want to invest in. Read about the present and past news about the company. Try to find information about the management of the company. Be critical about the business of the company. Ask questions like-
- What is the business model of the organization?,
- How much scalable the business is?,
- Is the business too much dependant on a particular thing- like monsoons or price of crude or movement of dollar?,
- Who are it’s competitors?
Ask smart questions and demand honest answers from yourself.
Checking the Profit/ Revenue of company: Once you have understood the business of the organization it’s time to check their financials.
- Visit the official website of the company and check the profit/revenue numbers for the past 3-4 years. These figures should show healthy improvement over past quarters.
- Check the EBIDTA/ PAT margin. EBIDTA is earnings before Interest, Deductions, Taxes and Amortisation. This tells you about the cash-flow to a company before all the deductions are made. On the contrary PAT is Profit after Tax. It’s desirable to have a low difference between the EBIDTA and PAT. Also a low ratio between Revenue to PAT/EBIDTA is good for the company.
Calculating Price to Earning ratio: This is the most simple and effective way to find the valuation of a company. Here Price is the rate at which the stock is offered and Earnings is the profit of the company. Divide the Profit by the number of shares issues to arrive at the Earning per Share(EPS). (Remember the profit should be calculated according to the percentage of the Equity offered to the public).
Now, P/E = Price of a share/ Earning per share
Usually a stock having a PE of 15-25 is fairly valued. Below this it is under-valued and over it it’s over-valued.
It is advised not to value a company blindly on the PE. A company should always be compared to it’s peers before a decision based on the PE is made.
How to invest in IPOs?
Invest in IPOs is simple. Open a demat account which is linked to your Bank Account. You should bid for the offer at a price band. The introduction of ASBA has made the process transparent and easy for investors now.
What is ASBA?
ASBA provides an alternative mode of payment in issues whereby the application money remains in the investor’s account till finalization of basis of allotment in the issue.
ASBA process facilitates retail individual investors bidding at cut-off, with single option, to apply through Self Certified Syndicate Banks (SCSBs), in which the investors have bank accounts. SCSBs are those banks which satisfy the conditions laid by SEBI. SCSBs would accept the applications, verify the application, block the fund to the extent of bid payment amount, upload the details in the web based bidding system of NSE, unblock once basis of allotment is finalized and transfer the amount for allotted shares, to the issuer.
We hope this post helped you to understand the IPOs better. This post will be regularly updated with more information.
Till then, Happy Investing. 
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