Six things to check before investing in IPOs

If you are among those who rush to invest in initial public offers (IPOs) of companies, you need to know how to decide which IPOs to invest in and which ones to avoid. If you go by the hype and the hoopla in the market, you may be in for a shock if the company goes down under. To avoid such an eventuality, you need to check out the quality of the IPO on certain parameters and only then decide whether to invest or avoid. So, here is a checklist for IPOs:

Company background: Check out the status of the company in the industry and dig out information about other companies operating in the industry and ascertain whether the company is an industry leader or a laggard. If the company is an industry leader, nothing like it; but if it is way below on the ladder, you better watch out. Also, find out about the competitive scenario in the industry and the kind of brand presence the company has in the market.

Company management: You need to check out the credentials of the promoters and management of the company in terms of their professional qualifications and experience in the industry. If the promoters and management appointees are longstanding professionals in the business, the company is likely to maintain high standards of corporate governance and management integrity, which is good for the investors.

Financial Performance: If the company has been growing consistently in terms of sales volumes, revenues and profits over the last three years and more, it means the company has an established presence in the market. Find out about the profitability of the company in terms of return on equity (ROE) and return on capital employed (ROCE). If it fails on the financial parameters, you would do better to avoid it.

Future prospects: The past performance of the company may have been good, but its future prospects too have to be good enough to justify your subscription to the IPO. Check out the sustainability and scalability of the company’s business model and its future plans.

Purpose of IPO: You need to know how the funds raised through the IPO are going to be utilised. If the company proposes to utilise the funds for greenfield expansion or for expansion of the existing capacity or for paying off debt, then it makes sense to subscribe to the IPO. However, if the funds are to be utilised only for meeting working capital needs, then it is better to avoid the IPO.

Valuation of the IPO: Compare the valuation of the IPO on the basis of PE and P/BV with the valuations of the peer companies. If the IPO is undervalued, then subscribe; however, if it is richly valued, then avoid.

If the IPO passes muster on most of the above parameters, then you can go for it, but if it fails, it is better to avoid it.