Investor guide: How to select right IPO for profitability?

The year 2021 was kickstarted with enthusiasm as liquidity and investor interest ruled the stock market. Consequently, Indian companies have been able to raise more than Rs 27,417 crore in the first six months through Initial Public Offerings (IPOs).

Surprisingly, so far, this is also the highest amount raised over the past decade! However, most of these funds were either used to bid goodbye to the existing PE or VC funds or existing shareholders and promoters. This year is indeed anticipated to be a noteworthy year for investing as various IPOs are lined up in the country in the coming months.

Some of the IPO stocks that were listed in 2020 are now trading above their issue prices. Some, on the other hand, have gained as high as 400% ever since they were listed. All these factors collaboratively have led to the emergence of IPO investing as a viable and appealing option for investors who are planning to enter the market.

However, what often goes unnoticed is that just like the stock market, IPOs come with their fair share of risks. With various companies planning to come up with their IPOs, finding the profitable ones can indeed be a tough and complex process. Hence, there are a few points that should be taken into consideration before taking the plunge.

The DHRP or the Draft Red Herring Prospectus is filed by a company to Sebi when it plans to raise money from the public by selling shares of the company to its investors in the primary market. It also enlists how the company intends to utilize the money that will be raised as well as the possible risks for the investors. Hence, it is advisable that the investors must go through the DHRP before investing in any IPO.

Before investing in an IPO, it is essential to know how and for what purpose the proceeds raised from the IPO will be used. If the company states that only debt will be repaid, then it won't be a viable choice to consider for investment. However, on the other hand, if the firm plans to raise funds to pay debt partly and use the other half for the expansion of business or corporate purposes, then the fund will eventually flow back into the business. Hence, it will be an attractive investment option.

One should always comprehend the nature as well as the working of the business prior to investing in any IPO. Once this is in place, you will be able to move on to the next step, which is to easily recognize the new growth opportunities in the market. It is this magnitude of the opportunity and the company's capacity to capture the market share that makes all the difference when it comes to growth and shareholder returns. These factors play a pivotal role in making the IPO investment an ideal choice for investors. However, it is strongly recommended that the investors should not choose to invest in an IPO if the business activities of the company are unclear.

Gathering knowledge about the management team and company’s strength

An investor should check the background of the management team and the drivers of the company before investing in its IPO. It is critical to have information about the founders, management as well as promoters since they are the ones who are driving the company and are responsible for its operations and brand image in the market. Furthermore, figuring out the key strengths and strategies of the company from the DHRP is also essential as it will help give investors an idea about the future prospects of the business in the market.

It goes without saying that any company that comes up with an IPO would have a good business model to sustain in the market. Hence, analyzing the potential of the business in the market is another important step to be kept into consideration before investing in its IPO. If the company performs well after raising capital, investors will be able to gain high returns on the investment made during the IPO.

Gauging the financial performance as well the health of the company with reference to the revenues and profits as well as their increase or decrease is a critical step while choosing the right IPO. If the profits are increasing, then of course investing in its IPO would be the right decision. Additionally, one should also check the valuations as the offer price may be undervalued or overvalued depending on the industry parameters and profitability ratios.

Furthermore, investors should also conduct a thorough analysis of the peers and competitors of the company via the assistance of the DHRP. This will help them understand if the valuations of the company are aligned with its peers or not. Reading the associated risk factors is also important to gather insights about the concern areas or risks associated with the company and its IPOs.

Being an investor, you need to have a clear thought process with reference to your investment horizon. You have to think through and decide whether you are planning to invest in the IPO to make a quick profit on a listing day or if you would want to hold the shares for long. This is important to be considered beforehand since the short-term strategy would depend on the current market dynamics whereas the long-term strategy would rely on the fundamentals of the company.

One should always conduct thorough research before making the decision of investing in any company's IPO. Keeping in mind the long-run growth potential of the company is an equally important step. The stock market is all about timing with a bit of luck! It is advised that you invest in the IPO only if it compliments your financial goals and is in sync with your risk appetite. Being skeptical but well-informed will indeed be the best route to take the correct decision and select the right IPO offering profitability!