It’s always difficult to differentiate between good or bad IPOs. A careful investor must identify potential companies through a detailed and extensive research
The Rs 470 crore Initial Public Offering (IPO) by miniratna Ircon International is in the news for full subscription of the quota limit for retail individual investors. The issue was subscribed 43 per cent till September 18. The offer for sale (OFS) received bids for 42,24,090 shares compared with the total issue of 9,905,157 shares and the Government is looking forward to offload Ircon shares in Rs 470-475 price band. So, should an investor invest in this IPO? What are the things that a retail investor needs to know before investing in one?
An IPO is the very first sale of shares issued by a company to the public. Prior to an IPO issue, the company is considered private with a relatively small number of shareholders, primarily comprising early investors, such as the founding members, their families and friends, and then later on professional investors, such as venture capitalists or angel investors. The public, on the other hand, consists of everybody else — any individual or institutional investor who wasn’t involved in the early days of the company and who may now be interested in buying shares of the company. Until a company’s stock is offered for sale to the public, the latter is unable to invest in it. One can potentially approach the owners of a private company about investing but they’re not obligated to sell anything. Public companies, on the other hand, have sold at least a portion of their shares to the public to be traded on a stock exchange. This is why an IPO is also referred to as ‘going public’.
Why do companies go public? Well, capital is a scarce resource and companies go public to raise money that can then be used in different ways like clearing debts, improving infrastructure, investing in research and development of new products, introducing new products, among others. Moreover, the company gets credibility and visibility after it gets listed on the stock exchange. This can increase scope for mergers and acquisition deals and also attract top talent in the industry. Additionally, because of increased scrutiny from analysts and investors, public companies can usually enjoy better, in most cases lower interest rates, when they issue debt. A privately held company has some benefits that are forfeited once it goes public. For example, any private company owner does not have to disclose much financial or accounting information about the company. However, once the company goes public or is in the process of issuing an IPO, its financial information, strategic plans and other policies are up for scrutiny which can be good in some cases, as increased financial scrutiny during the process of going public will get them better debt rates when they are issuing it.
When a company is planning to raise funds from the public, it provides detailed information about its business operations and financials through a draft red-herring prospectus or offer document. This includes details about its promoters; reason for raising money; how the money will be used; risks involved with investing in the company and so on. Investors should bear in mind that it does not provide information about the price or size of the offering. And how should investors choose an IPO for investment? The answer is research. The first and foremost thing any investor should do is to research various aspects of the company. Now, the question is: Why are funds required? It is obvious that if a company is clearing its debt with the public’s money, and has no plans to invest and grow the funds, then that IPO is a bad choice. However, if funds are raised for investing in R&D or a new product line, which could change the future of the company, investment in such an IPO is worthwhile. So, it is very important to understand in what ways the company wants to use its funds.
In addition, an investor should research about operations of the business, market share, future growth plans et al. One of the crucial investigations that any investor should undertake is to understand the management — their honesty, transparency, ethics and values. Honest leadership means that an investor’s money is in safe hands. Second, try and select an IPO with strong brokers and underwriters because generally, quality brokerage companies bring quality public issues. Scepticism is a positive attribute to cultivate in the IPO market. As there is always a lot of uncertainty surrounding IPOs, mainly because of the lack of freely available information, like in other already listed companies, one should always approach an IPO with caution.
Although it is difficult to identify which IPO is good to invest in, a careful investor may be able to sift through riff-raff and identify potential companies through a detailed and extensive research. In case, if an investor loses an opportunity to invest in an IPO, he must follow the company’s progress and if it is a fundamentally strong company with good operations, transparent management and robust financials, he must not leave an opportunity to buy the stock in the secondary market the next time it falls.
(The writer is Assistant Professor, Amity University)