Indian markets are yet again at new highs and investors are full of greed. During the last 9 months, Nifty50 moved from 7900 to 10150 which converts to 28% returns. This sudden euphoria of the market has also increased the number of IPOs offering. Today in this post we will learn how to pick a right IPO stock.
In 2017 till date around 27 IPOs have been filled by various companies. The good thing about all these IPOs were
- None of the IPO was withdrawn.
- Every IPOs was oversubscribed.
- Around 85% IPOs listed with premium which gives a quick return on investment.
- Most of IPOs were offered at a premium valuation.
Recent IPOs in 2017
Factors responsible for poor listing of some IPOs
We saw that some of the IPOs were not able to give listing gains in-spite of the market at the peak. The major factors which caused this were
- The company was not having decent growth record in last 3 to 5 years.
- The company’s valuation was very much stretched against their peers which were already listed.
- The company has opened a big issue size. For more than 2000 Crs.
Red herring prospectus
Any company which goes for an IPO files a document known as Red herring prospectus with SEBI (government regulator). This document is prepared by the investment bank known as Book Running Lead Managers after proper background and financial records analysis of the company. So, this document contains everything about the company, its promoters, stakeholders, its main business, lawsuits against company or promoters etc. This document is very exhaustive and is usually over 500 pages.
How to evaluate an IPO
All broker/financial advisers usually extract data from Red herring prospectus before giving any rating to an IPO such as Subscribe/Avoid/Neutral.
Before bidding for an IPO, an investor should go through following things
- Look at the 3 and 5-year profit and revenue growth. These both should be at least positive or constant over the period. You should avoid a companies with volatile numbers.
- Debt to equity ratio of the company should be at least constant or decreasing. You should be careful in selecting a company with very high debt/equity ratio (>2).
- The competitive edge of the company. For eg. Market leadership or Unique product or big client base.
- Valuation against listed Peers. Investors should use P/E ratio to compare valuation among peers of the company. An Investor should be careful with the company having very high P/E ratio. He should also compare P/E among the peers to get marker justification of the business.
- Purpose of the issue. Most of the companies use the money to pay their debts.
- An Investor should check the credibility of Promoters. If promoters are not looking promising then also IPO should be avoided.
An investor should not worry about calculating these numbers by self. Usually, most brokers publish IPO review ahead of the IPO. An investor can use those numbers to make his/her own decision. Any detail information about the company could be easily obtained from Red herring prospectus.
Types of IPOs
Whenever any company raise money through IPOs they are under these 3 categories
- Fresh issue: Under this type of issue/IPO, the company will get the raised through IPO.
- Offer for sale: The company promoters or previous investor’s (VC or Angel ) are selling their stake through the IPO. The company will not get any money from IPO.
- Combination of Fresh issue and Offer for sale
By knowing the type of IPO, an investor can understand the purpose of issue and promoter’s confidence in their business.
Now, we will take an example of Matrimony IPO and will analyse it based on above-given parameters.
Analyzing Matrimony IPO
Company’s past sales and profit figures seem to be very volatile and do not show any trend. Now, an Investor should become very cautious about investing in this type of company.
Issue Type of IPO
The company is raising 500Cr and out of which, only 25% is the fresh issue. An Investor should know that majority part of IPO proceeding 75% will be taken by Private equity funds and promoters.
There was a litigation claim against the company made by Mr Rajan Desai and Real Soft, Inc and company paid off 53 Cr in 2016. There are also few cases related to PF and FEMA regulation pending against the company.
The company has no unique moat or a competitive edge that is why any new player or old ones with aggressive marketing can gain significant market share.
Now analyzing this IPO would be easy for anyone who is reading this post. We could at least say this IPO will not give huge listing gains and an investor should be cautious about this investment. He should do complete homework before making any decisions.