What is an initial public offering?
When a company first issues common shares to the public, it is called an Initial Public Offering (IPO). This is a process in which an unlisted company (not listed on the stock market) raises capital from the public. Once the process is complete, the company’s shares are listed on the stock exchange.
Points to consider before investing in an IPO
1) Company Background – Understand company business model, company products, company revenue mix (depending on geography, product, and region)
2) Customer Base -Name of Customers, Total Number of customers. Is the client large companies or small companies?
3) Industry – The industry in which the company operates. Current and future industry prospects.
4) Offer price vs. Earnings per share – Offer price is the price at which the company offers its shares to the public. Earnings per share (EPS) is the company’s net income divided by the company’s total shares. It is an indicator of the profitability of the company. Compare the offer price to the company’s EPS and find out how many times the offer price is a multiple of EPS. For example, Company A came out with an IPO and the price band is Rs 120-150. Next year, company A’s EPS is Rs 30. In this case, the offer price is 5 times (150/30) of the EPS. Always consider the highest price of the price band (Rs 150). If the multiple is higher, it means you are paying a higher premium for the share and vice versa.
5) Lead Managers – Check the Lead Managers of the IPO issuance. If Lead Managers have a good brand, this also implies the quality of the company. An important point to keep in mind is that good top managers definitely will not like to be involved in sub-par companies.
6) Red herring brochure: Please read the red herring brochure carefully and check all the risk factors of the company.
Since investing in equity shares carries a high degree of risk, be sure to verify all information before investing in an initial public offering. The risk of an IPO is the same as the risk of a stock, so based on your risk appetite, make your decision. Most of the information mentioned will be available in the red herring prospectus and on the Lead Managers company website.