Strategies & Tips to Invest in an IPO

Strategies & Tips to Invest in an IPO

Is there a strategy to identify the right IPO and allocate money to the IPO. After all, in any IPO investment, there is not as much information as you can get in listed stocks. Hence, when you buy IPO, there is the risk of inadequate information.  However, it is still possible to formulate an IPO investment strategy where some basic rules can go a long way in helping you invest in the right IPO. The IPO strategy would be based on some worldly wisdom and also on some in-depth analysis of the data available pertaining to the IPOs.

Here let us understand in greater as to what is IPO in trading and let us also look at what is initial public offering or IPO of shares. However, there are two very important aspects of any IPO or initial public offering. First is how to choose best IPO from the array of IPOs available on offer. The second point is when can I sell IPO shares? You can sell the shares as soon as it is listed provided you got the credit in your demat account. Ensure that your trading account is activated since without the trading account you cannot sell the shares. The rest of this section will be dedicated to tips and strategies to invest in an IPO.

Yes, you need to do your homework

You may have the best advisor advising you and you may have the finest broker suggesting you invest in the IPO. However, it makes a lot of sense to do your own independent homework before you invest in the IPO. Reading the RHP can give a lot of clarity to you about how good the IPO and whether the IPO fits into your framework of an ideal IPO investment. RHP or the red herring prospectus is your sole access to information so make the most of it. It would be ideal you also talk to some sectoral players in the business before committing your money. Remember it is your hard earned money after all.

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Table of Content

  1. Yes, you need to do your homework
  2. Understand how the IPO funds are being utilized
  3. How good or how bad are the promoters
  4. One simple benchmark is the lead manager track record
  5. In the retail quota, bid at the cut-off price
  6. Split your IPO application among  your family members
  7. Should you exit on listing or wait longer?
  8. Always doubt the valuations

Understand how the IPO funds are being utilized

This may not be too important if it is an offer for sale. There are no fresh funds coming into the company. However, in the case of a new issue, it is essential that you understand how the funds are being put to use. Just an example. Be wary if the funds are being largely utilized for working capital expenses or for general use or for future acquisitions. Prefer IPOs where the prospectus clearly states the cost of the project, expansion project details etc. You must also verify the veracity of such figures before committing funds. One question people ask is if it is a good idea to use IPO funds to repay loans. There are two ways to look at it. Firstly, if the company is only bogged down by high cost of funds then the IPO can help them improve solvency to a great extent. However, using equity to repay debt makes an assumption that the cost of equity is lower than the cost of debt, which is not true. So, using IPO funds for debt repayment can be a double edged sword. 

How good or how bad are the promoters

In the case of IPOs like Adani Wilmar, there was not much of a background check to do since the promoters are among the biggest wealth creators in India. However, most promoters have not been heard of till the IPO. So, how do you do your channel checks on the promoter. First use the secondary information. Look at websites, articles etc on the promoters. Also check for discussion and chat forums where you can find enough such information on the promoters. You don’t need to take everything at face value but you can get some good ideas. Verify if there are too many legal cases pending against the promoters or if there are ED / PMLA investigations on. Such promoters are best avoided. Most of this information will be available in the prospectus itself. When you invest in the IPO, you actually invest in the promoter, so quality of promoters matters a lot.

One simple benchmark is the lead manager track record

Normally, larger book running lead managers are choosy about the IPO mandates they take up since they have a reputation to protect. Hence, it is better to go for IPOs backed by well-known investment bankers who have a good track record. As an added analytics, you can also look at how the IPOs managed by the promoter have done in the last 1-2 years and that will give you an approximate idea. Don’t fall for hard selling tactics. 

In the retail quota, bid at the cut-off price

If you are applying in the retail quota, should you put a bid at the cut-off or should you quote a price. The value addition in quoting a price is very limited. You may quote too low and end up losing your chances of allotment. Instead, just bid at the cut off price. Also don’t rush to invest on the first day itself. Wait for the book to build up and then you can take a call since the post issue listing is normally a function of the subscription levels.

Split your IPO application among  your family members

If you plan to apply in the retail quota should you use up the full quota of Rs2 lakhs in one name or apply across family numbers. Duplicate applications are not legal but each of your family members can apply. In the retail quota, more applications you put, greater are your IPO allotment chances since the intent is that more people get allotments. This is something to remember in retail quota. Of course, funded applications are put in the NII quota but for that you need to evaluate the cost of funding first.

Should you exit on listing or wait longer?

There are a few important things to remember here. If you get a good listing price, it makes sense to book the profits and come out because selling pressure on the IPO is likely to come at some point. At that point you can always get back in. Most IPOs see selling pressure when the lock-in period of anchor investors ends and that creates a lot of selling pressure as we have seen in the various digital IPOs. The idea is to have an exit strategy in place when you invest in the IPO itself, so there is clarity post listing.

Always doubt the valuations

The idea is not to become an awful pessimist or cynic. Take the example of many of the digital IPOs. All were quoting at fantastic valuations even when they were not making profits. Eventually, reality caught up with most of them. Look for benchmarks in the Share market app. For example, a new fangled FMCG company cannot expect the same valuations as Hindustan Unilever or Nestle India. That has been built over many years. Also, be cautious when the projections look too rich compared to past performance. There is a lot of talk about how industries are getting disrupting and how they are changing. Remember, the basic story of valuations remains the same.

This is not an all-in guide. Hopefully, some of these ideas should help make a better IPO choice.