People get too excited when companies that are well-known or have built a good reputation in the market decide to go public. The media creates so much buzz about a brand that even people who aren't interested in it are drawn in by it.
Companies shift from private enterprises to public ones by issuing their shares for various reasons. A few reasons are the expansion of operations, research and development. Thus, companies issue IPO when expanding at a high rate and need additional funds. Meaning they have been doing pretty well till now.
Now, looking at all the hype, everyone wishes to put their money into that IPO. Moat investors aren't aware that not all IPOs perform as per the expectations, and investing in every IPO that comes your way is not advisable.
Here, we'll see what misconceptions investors have about IPO and what you should consider before investing in such offerings.
What is an IPO?
Initial Public Offering refers to when private companies shift to public companies. It can also be said when companies issue their shares for the first time to the public. Before issuing the public offerings, the company's shareholders are usually its founders, venture capitalists or angel investors. But after issuing the shares to the public, various other types of investors also become the shareholders of the company. The types include non-institutional investors, individual retail investors and qualified institutional investors.
Myths about IPO in the minds of shareholders
In this section, we'll look at various misconceptions investors have about new public offerings in the market.
Companies offering shares to the public must be financially sound
It would help if you remembered that a company may have performed in the past, but its future is highly uncertain. There may be certain global and economic factors that could function against the company. Hence, an IPO does not guarantee financial stability in the future.
Investments in such offerings will always generate high results.
It is certainly not true. Such investments are highly risky and volatile. Meaning you could even lose all your money. Though future forecasts are made about the growth of a company, what if a situation like Covid-19 happens again? In such conditions, all the predictions can prove to be untrue.
Everyone is mad about it, and you should be too.
Even if everybody is over-excited about the company's offerings because of the media or the brand's reputation, it might not be a good option for you. Even well-known brands fail miserably sometimes. Hence, the decision to subscribe should depend on your research and goals and not on the excitement levels of the public.
What should you consider before buying a company's initial public offerings?
Since now we have busted some of the most common myths, it's time to enlighten you on deciding whether an investment is worth it. So, let's discuss a few points.
Know your purpose of investment
You should be clear with your "why". Why are you investing? Are you investing because your cousin or neighbour is doing it? Or are you doing it for the listing gains? If you're doing it for such lame reasons, refrain from doing so. Such investments are only worth it if they align with your financial goals.
Know everything that the brand or business is about
Before making a substantial investment, you must be aware of everything the business does. Spend a significant amount of time understanding the brand's business model and researching the company. Only invest in businesses that have high growth prospects not only in the short run but also in the long run. If a company has high growth expectations, you can only expect your investments to grow. And just because the business model seems fancy, it doesn't signify its growth.
Have a look at the background of the firm
As a potential investor, you must know what the company has been doing in the past. This includes everything like checking how their products/services have been performing, how often the management changes, what the qualifications of the promoters are, and so on. Only keep stable companies on your list and discard others.
Check the financials
Checking financial data of the past months or years can give you a clear prediction about the future. In financials, you must have a look at the debt-equity ratio, cash flow statements, the firm's earnings per share etc. To check if it is suitable, you may google the ideal numbers and then crosscheck with the company's data. This is the one step you shouldn't miss at any cost.
Analyze the risks associated with the investments
While checking the financials, you may get an idea about the risk associated with investing in the firm. But to know more about it, you may check the DRHP. It is a prospectus issued at the time of the offering and contains information about all the types of risk involved.
Check grading
You may also check an IPO's grading. However, it doesn't guarantee good results, as companies with good grading couldn't perform well in the past. Hence, you can check it but decide only after considering all the above parameters.
Final verdict: Is investing in an IPO good or bad?
It can be both. Good when you do proper research, check all the parameters and then make a decision. Bad when you buy because of the hype created by the company or the media and without any research. But you can not ignore the fact that such investments are highly volatile and prone to high risks. There are a lot of benefits to investing in IPO, but it requires a lot of effort on your part as you have to go through a lot of data, credentials and stuff. The goal of investing in new stock offerings must be clear to you. If you're doing it for the listing gains, extensive research may not be required, but if you are planning to stay invested for longer periods, in-depth research about the brand is required. In the end, we can say that such investment options are suitable for investors having high-risk tolerance.
Frequently Asked Questions (FAQs):
Q. What should I know before investing in an IPO?
You must research the company's financials, its business model, its background, the risks involved, and the general health of the company.
Q. Is it a good idea to invest in an IPO?
Investing in such options is highly risky and highly volatile. You shouldn't invest because of the hype. You must keep a lot of parameters in mind before putting in your money.
Q. Is investing in an Initial Public Offering always profitable?
Yes. Only if you research well and invest in the right offering. No, if you invest in every offer that comes your way.