Things to consider before investing in IPO (Initial Public Offering)
What is IPO?
A public offering, in which a private company sells its shares to institutional investors, as well as retail investors, is known as IPO (initial public offering) or stock launch. Investment banks help the private company which offers its shares (Issuer) to list their shares to multiple stock exchanges. After listing, the company’s shares are traded in the open market. Companies have to follow all the protocols and must meet the requirements given by exchanges and SEC (Securities and Exchange Commission) to hold an IPO. If all the requirements aren't met, the company cannot be listed. As a retail investor, one should consider the following things before investing:
1. Purpose of Funds Raising One should know how the company is going to use the funds raised through IPO (Initial Public Offering). Usually, there are different reasons behind fund-raising, but the most common ones are repaying debt, expansion of business or for corporate purposes. Knowing the reason can tell if the funds will be used properly; accordingly, the investor can decide to invest.
2. Company’s Valuation Checking the valuations of the company can tell you whether the offer price is overvalued or undervalued. It depends on the financial ratios and also the sectors in which the company is operating. It’s essential to know about the valuations of the company, as it gives us a glimpse of the company’s future growth.
3. Understand Business Model Investors should understand the exact business model of the company. After understanding what kind of business the company does, one can recognize the company’s capacity to capture market share and beat its competitors.
4. Financial Performance It is important to know the past financial performance of the company before investing. One should check whether the company’s revenue has been increasing in the past years. It’s crucial from the perspective of long-term investment.
5. Holding Period Before investing in IPO (Initial Public Offering) investor should decide whether he/she wants to hold the stock for the long term or wants to exit the stock on a listing day having listing gains. Different strategies are available, depending on the holding period of the investor. Trading strategies depend upon current market fluctuations, whereas long-term ones rely on the company’s fundamentals.
6. Strengths and weaknesses of the company One should analyze every strength as well as weakness of the company before investing in its IPO (Initial Public Offering). Read everything about the company. It will give you a better understanding of the company’s plus points as well as negative points.
7. Gray Market Premium Before a company gets listed on the stock market, it’s traded in the gray market. Retail investors can decide to invest after watching the company's gray market premium. A gray market premium of more than 50% indicates fair listing gains, which helps short-term investors to generate profits.
8. Do not fall for the Hype Do not fall for the hype surrounded by the IPO, study all the pros and cons about the company, only then decide to invest.
9. Study all the Risk Factors Study all the potential risk factors mentioned by the companies under ‘Risk Factors’. It can help make a better decision whether to invest or to avoid.
10. Give a glance at the grading of the company There are higher chances of profits in IPO if the company has a higher grading. Do not rely entirely on the grading of the company; check the other factors too before making your final decision.
If you consider all the above things before investing, you can surely see the profits on your investments.