IPO has become one of the biggest buzzwords in the financial world, hasn’t it? More than 100 Indian companies have rolled out their IPOs in the past couple of years. Amongst these, a lot of startups, too, have caught the IPO fever.
But the way some IPOs have underperformed and their shares tanked after the companies went public, doesn’t it make sense to pay due diligence about a company and its IPO before putting in your hard-earned money?
After all, mistakes in this process can not only make your portfolio bleed red but may also make you sit on a pile of losses.
So, if you too are struck by the FOMO and seem eager to invest in IPOs, then just pause and go through these common mistakes when investing in IPOs.
1. Failing to understand the company’s business model
Would you give away your hard-earned money to a stranger or even a known person without asking the reason or intention? Probably not, right? So how can you invest in a company’s IPO without understanding or paying attention to its business model?
Even one of the world’s most successful investors, Warren Buffet, warns against investing in companies with no clear business model. He says “Never invest in a business you cannot understand.”
So, make sure you go through and understand the company’s business model and fundamentals before investing in its IPO, irrespective of how much hype is surrounding it.
2. Blindly falling for the company’s name
Another big blunder a lot of investors tend to do is blindly investing in a company’s IPO just because it has a big brand name. Does a big brand name guarantee big returns too? If that was true, everyone would earn big profits and only invest in such companies!
Ultimately, it boils down to the company’s financial stability, performance, fundamentals, business model, plans etc. So don’t follow the herd mentality when putting your hard-earned money into a company’s IPO. Do the required research irrespective of whether it’s a big or small company, and focus on its fundamentals, financial performance and business plans. Don’t forget to check what the company intends to do with its IPO funds.
Usually, chances of good returns are higher if the company aims to utilize the funds for purposes such as expansion as opposed to the company using the investor’s money for debt repayments.
3. Failing to diversify your portfolio of companies
If you have invested in IPOs before or plan to do so for multiple companies, it’s important to diversify the portfolio. Try investing in IPOs of companies belonging to different sectors, such as tech, infra, pharma, financial etc as diversification reduces the overall risk of the portfolio. It also helps in tackling market ups and downs wherein a particular company’s stock may perform well while the other one in the portfolio might be bleeding! So, diversification provides that much-needed balance and reduces the risk for your overall portfolio thus minimizing the risk of losses too.
4. Not paying attention to the prospectus
The main document to focus on when investing in any IPO is the prospectus. Never ever skip reading the prospectus of any company which is planning to go public and where you plan to invest through its IPO.
You can download the company prospectus from its official website or even from SEBI’s website, and give it a thorough reading. The prospectus acts as a good starting point for your research when contemplating the thought of investing in an IPO. The prospectus mainly contains information regarding the company’s financial performance, the reason behind issuing an IPO, details about the promoters, dividend policy, risks, regulatory and statutory disclosures, offer information, details about the management etc.
5. Ignoring valuation and pricing
Another aspect of IPOs that you as an investor should not ignore, is the valuation and pricing.
Valuation is the worth of the company whose IPO you’re interested in. There are not one but multiple techniques used by analysts and economists for arriving at a company’s valuation. Numerous aspects like the business’ management, the composition of its capital structure, prospects of future earnings, the market value of its assets, number of stocks being sold in IPO, potential growth rate, financial performance, and the current market price of companies listed in the same sector etc are amongst the factors and metrics taken into consideration during valuation.
So, you should ideally see how the valuation of a company fares vis-a-vis existing companies and competitors in the same industry when contemplating the idea of investing in its IPO.
Also, there are techniques such as Return on equity (ROE), Price to earnings (P/E) ratio, price to book ratio etc that can be used to judge the valuation better. It’s always a good idea to learn about these ratios. To add to your own research, you can even look at what the financial analysts and economic experts are saying about that IPO, but ensure that the final decision is yours. After all, it’s your hard-earned money!
Remember that a successful IPO hinges on consumer demand for the company’s shares. Strong demand for the company during the IPO is likely to lead to a higher stock price and valuation. Besides the demand for a company’s shares, there are many other factors that determine an IPO valuation, including industry comparables, growth prospects, etc
Last but not the least, remember that scepticism is a positive attribute when it comes to investing in IPOs. Whenever you think of getting your skin into the game by investing in an IPO, it’s always better to tread with caution than to regret it later!
For the latest financial news and interesting content, keep reading Indiatimes Worth. Click here.