Should You Invest in IPO? Factors to Consider for Smart Investing

3 min read

With 2021 seeing a rush of successful IPOs in India, and a huge number of investors seeking to encash attractive listing returns, it is important to be able to evaluate investment opportunities yourself instead of simply buying into the general craze.

So should you apply for every IPO that is announced in the Primary Markets? How do you decide which one is more attractive in terms of long term holding returns or immediate listing gains? 

Reading the IPO prospectus is always a good place to start, and then there are other factors to consider which we have highlighted in today’s post.

Let’s discuss what questions should investors be asking before investing in an IPO, and how can you avoid IPOs that are not likely to succeed in the short or long term? Let’s look at some of the critical factors that should be considered before investing in an IPO.

1. Understand the motive behind Company’s IPO and the use of funds

As companies going public seek to raise funds from investors, there should be a clear statement in the prospectus about how the money will be used.

Knowing where your money is going should be important to you and will play a role in the performance of your investment. Companies that are putting the funds raised back into the business will have a greater incentive for the business to grow, versus when early investors or founders are primarily cashing out their held stocks for return on their investment with ambiguous expansion plans. 

Importantly, keep a sharp lookout for anything that will benefit third parties, such as excessive fees being paid out to advisors, as occurs in some floats. Overall, companies putting funds towards growth initiatives are more likely to have a greater long-term outlook and provide a more stable investment.

2. Understand the Company’s Business

Investment guru Warren Buffett attributes his success partly to remaining within his “circle of competence”. If he can’t work out what a company is doing, he believes it is highly likely that lots of other people have the same difficulty – therefore he stays away. And he’s right.

It is simple yet integral advice, and something to keep a close eye on when investing. Companies should be clear in the prospectus about what their product or service is and the problem they are solving or the gap in the market they are filling.

Once you understand the business, identifying the market opportunity is your next step. The size of the opportunity and the company’s ability to capture market share can make all the difference when it comes to growth and shareholder returns.

3. Be clear with your investment strategy/goal:

Before investing in any IPO, one should have a clear investment horizon. You need to decide if you are planning to invest in the IPO for just trading purposes on the listing day or want to hold the shares longer. The reason behind this is that trading strategy could rely more on current market situations, hypes and broader public emotion (more in point #4 below) – while on the other hand,a long-term strategy will hinge on the company’s fundamental analysis. 

4. Observe the Public Emotion as well

Public sentiments towards macro-economic factors, government policies, businesses branding, PR, CSR, etc. could also influence listing gains, at least in the short term. 

As already discussed, a vital factor to keep in mind before investing in a new IPO is to focus on the reasons you want to invest in the first place. Establish a clear and strategic reason to purchase the shares and check off the herd mentality or emotional turbulence to stick to your research and analysis.

FAQ: What is an Oversubscribed IPO? 

In an IPO or public issue of shares, there are several stages. Once the company files for an IPO and its application gets approved, investors can subscribe to its shares within a set period. The share issue of a company in an IPO usually remains open for anywhere between 3 to 10 days. During this period of IPO subscription, retail investors and others can file for allotment of the company’s shares.

The shares in an issue are allotted to the different categories of investors, namely,

  • Retail Institutional Investors (RIIs), 
  • Qualified Institutional Buyers (QIBs) and 
  • Non-Institutional Investors (NIIs)

There is a cap of Rs 2 lakh on the value of bids made by retail investors in an IPO.

There are three possible scenarios here- an IPO can be undersubscribed, fully subscribed or oversubscribed. For shares of the company to list on the exchanges, SEBI requires at least 90% subscription to the issue. Otherwise, the IPO is scrapped and the money returned to bidders. 

An IPO is said to be oversubscribed when the number of shares on offer is less than the demand for the same during the IPO subscription process. This means that investors have applied for a greater number of share lots than what was put on offer by the company. 

Oversubscription of an IPO shows a high interest of the public in the shares of the company.

For the retail investor category, SEBI says that if this portion of an IPO is oversubscribed, then the share allotment must be done in such a way that each investor gets a minimum of one lot. Thereafter, the remaining shares are allotted proportionately. This holds true for issues with a small oversubscription. However, if an IPO is oversubscribed to such an extent that all investors cannot be allotted a minimum of one lot each, then the share lots are allotted to subscribers using a lottery system. In such a case, many subscribers may not be allotted any shares at all! 

If you’re wondering whether to apply for an upcoming IPO subscription or not, contact your ShareIndia RM today and get access to relevant information and research. ShareIndia also shares expert analysis for every IPO opportunity (for FREE, accessible online on our websites and social channels) that can help . To follow us online and create your own account, visit here. 

Disclaimer: Any Advice or information in the post is general advice for education purpose only and is not responsible for generating any trading profits for anyone, please do not trade or invest based solely on this information.

Leave a Reply

Your email address will not be published.