Are you a first-time IPO investor?
Even if IPOs appear attractive with expectations of high returns, they come with risks and complexities, cautions Sheetal Jhaveri and shares her checklist to help you navigate through the world of IPOs.
In a company's existence, the initial public offering, or IPO, is a significant event. For the first time, a private business offers its shares to the general public, opening the door for fresh capital, more publicity and the opportunity to own part of the company by individual investors. But even if IPOs appear attractive with expectations of high returns, they come with risks and complexities.
This guide aims at equipping beginners in the stock market with critical knowledge that will enable them navigate through their first IPO.
Understanding IPOs
What is an Initial Public Offering (IPO)?
A traditional IPO is when a private company sells newly issued shares of its common stock to underwriters (that is, investment bankers), who resell the shares to institutional and retail investors on a stock exchange. But the main question remains:
Why Companies Go Public?
• Raising Capital: Companies usually go public mainly to obtain funds. The funds raised through IPOs are employed for various purposes, including research and development, marketing activities, and acquisitions, or repaying debt.
• Liquidity for Existing Shareholders: An IPO is an exit strategy for early-stage investors and employees who own equity in the company.
• Improved Credibility and Visibility: The status of being listed boosts corporate reputation, attracting potential partners and employees.
The IPO Process
The whole process before the launch typically takes about six to nine months. There are numerous processes that a company undertakes before they become public as underlined:
- Appointing investment bankers/underwriters: The investment bankers/underwriters carry out the IPO process and act as intermediaries between the company and the investors.
- Registration of IPO: The investment bank and the company prepare a Red Herring Prospectus (RHP) with all the business details. The RHP is one of the most essential documents for a retail investor. The document contains information about important definition, risk factors, use of proceeds, industry description, business description, management, financial information, legal and other information.
- Cooling-Off: The period when SEBI verifies all the facts and looks for errors, omissions, and discrepancies. Only after SEBI approval can the company set the IPO date.
- Applications to stock exchange: Where the company plans to float the issue.
- Creating a Buzz: The company must ensure excitement about the IPO, like launching a new product or a movie.
- No trading for internal investors: To help stabilise the market without additional pressure, internal investors are not allowed to trade.
- Bidding period: The bidding period is usually for five working days when it is open to retail investors to apply in the IPO.
Key Considerations for First-Time Investors:
- Research and Due Diligence: Ensure that you do complete research before you invest.
- Company Fundamentals: Evaluate a business's financial health, business model, competitive landscape, growth prospects etc. Pay attention to SEC filed prospectus.
- Management Team: A company's success is primarily influenced by its management's experience and track record.
- Market Conditions: Broader market trends and economic conditions can affect the performance of an IPO. Ask yourself whether it is time for investment or not.
- Risks Involved: Analyse the risk involved and your risk taking capacity before investment.
- Volatility: Initial public offering stocks are usually highly volatile with large price fluctuations occurring within short periods after listing.
- Lock-Up Periods: Often insiders are restricted from releasing their shares on the market until the expiration of such periods following IPO. As soon as it ends, the entry of new shares into the market can affect stock prices.
- Limited Historical Data: Unlike established public companies, new enterprises going public don't have many years of financial statements making it difficult to foresee their future profitability
Investing In IPOs? Consider these factors
- Focus on the long-term: Have this in mind when you are investing in IPOs. Concentrate on the company's future performance for longer, not just within days or months.
- Diversify your holdings: Don't put all your eggs into one basket. Ensure that your investments are widely spread so that if one fails, there will be others to stand.
- Start small: Maybe begin with lower amounts of money to get into the IPO market with less risk you take.
How To Participate In An IPO?
- Direct Purchase: Individual investors can participate in IPOs through brokerage accounts that offer access to IPO shares. However, gaining access can be competitive, as institutional investors often get priority.
- Buying After the IPO: Another approach is waiting until the company starts trading on the public market. This allows for more price stability and information on the stock's performance.
Misconceptions about IPOs:
- On the day of the listing, the IPO will open positively: This is not always true, even though some companies see a big first-day gains during their initial public offerings (IPO). Other factors highly influence these performances, and you might not see any gains for an extended period of time.
- Only The Rich Invest in IPOs: Online brokerage platforms have made buying shares from an IPO easier for retail investors. However, minimum investments could be made based on specific requirements regarding investment level.
Conclusion:
For novice investors who want to invest early in a corporation's life cycle, purchasing its shares at an IPO can be exhilarating; nonetheless, they must approach this form of raising capital with carefulness, extensive studies and recognition of risks.
Information saves individuals from costly mistakes. Some authors also recommend prudent investment strategies for individual investors to make well-considered choices at IPOs
Sheetal Jhaveri, MBA (finance) and a certified financial planner, is the founder of Dhanplanner, an investment advisory firm.
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Disclaimer: This article is meant for information purposes only. This article and information do not constitute a distribution, an endorsement, an investment advice, an offer to buy or sell or the solicitation of an offer to buy or sell any securities/schemes or any other financial products/investment products mentioned in this QnA or an attempt to influence the opinion or behaviour of the investors/recipients.
Any use of the information/any investment and investment related decisions of the investors/recipients are at their sole discretion and risk. Any advice herein is made on a general basis and does not take into account the specific investment objectives of the specific person or group of persons. Opinions expressed herein are subject to change without notice.
