5 golden rules about the IPO for beginners – In simple terms, IPO is Initial Public Offering by a company. When a privately owned company wants to be public by offering its equities to the public, the process is called the IPO process or initial public offering. In the process, the privately owned company listed itself on the stock exchanges for public trading or public participation in its equities.
There are 5 golden rules about the IPO for beginners investing in IPOs. It is not always that an investing in IPO will give you a rich return. Most people think of getting a big return by investing in an IPO. Most of the time IPO is just like other stocks trading in the bourses. High-profile companies create headlines in the mind of the public through advertisements for a high price gain. However, most of the time listing gains of those IPOs disappear.
The IPO process of a company is a different topic and we have discussed the topic in another post. In this post we will discuss – is IPO for beginners in the stock market.
Let us see how a beginner should approach investing in IPOs.
Why do privately owned companies go public?
Companies start with low capital and from time to time they need funds to grow. Capital requirements for companies drive the IPO market. The valuations of the companies coming up with IPO also need to be reasonable.
IPO is an alternate form of fundraising for companies to meet their capital requirement. Companies assess both their liquidity needs from time to time and decide the way they would raise capital. Raising capital through debt is risky for the companies as the interest burden will affect their bottom line. Again, companies assess the market conditions before deciding on IPO. In simple terms, the owners or promoters of the company sell some portion of their stake in the company to the investors publicly and allow its equity to trade freely in stock exchanges.
What is the difference between a PIPE and an initial public offering (IPO)?
PIPE in simple terms Private investment in public equity. When an institutional investor, big investor, or mutual fund buys a stock of a company, they usually buy stocks directly from the company at below the market price. Through this method, companies can raise funds easily without following the stringent regulatory process of SEBI for IPOs. However, these big investors negotiate with the company to get equities with a lower valuation. That is a loss for the issuer companies.
On the other hand, Initial Public Offering (IPO) has a much better way to raise capital from the public with a fixed valuation determined by the lead managers. The valuation depends on certain criteria fixed by the market regulator SEBI in the case of India or SEC in the case of the US stock market.
Companies go through different life cycles. Start-up companies need seed funds to grow. Most of cases, promoters gather the required fund themselves. In many cases venture capital, angel investors invest in those companies as seed capital looking at the potential of the company’s future.
As a next step, companies go for a series of funding rounds to grow their company before coming for an IPO. After the IPO a company becomes a public company and is at the end of one stage in a company’s life cycle. During the IPO process, many of the original investors or promoters want to sell their stakes. Similarly, venture capitalists or angel investors in more established private companies that are going public also may want the opportunity to sell some or all of their shares.
As a practice, companies pursue an IPO to raise capital to meet their additional capital requirement for growth, to give an exit to the existing investor, or to reduce their debt. Through an IPO process, companies can get a huge amount of publicity that creates a brand name for the company.
Once a company declares IPO after approval from the market regulator, retail investors can invest in those IPOs. There are various risks associated with a beginner investing in IPOs.
Are initial public offerings good investments
Yes, most of the time it is a good investment if there is scope for growth in the company. For example, Avenue Supermarts Ltd (DMart) share was listed at around INR 600 odd level and now the stock is trading at around INR 4000 level. This is over 6 times the listed price. Similarly, many companies that have been listed recently, such as the DCX system have the potential to trade at a higher level 2 years down the line.
However, are all IPOs performing well? My answer is a big no, not at all. Look at Nykaa, PayTM, and Zomato, these new-age companies failed to perform well in the second life cycle. Their stock prices fell miserably in the exchanges and took a lot of investor money. This raises a question mark on IPO valuation. Promoters or investors of the companies are trying to value market opportunity, not the business. So, investing in IPOs is not an easy job.
The best way to invest in IPOs for beginners
Investors should be more selective, with a focus on profitability, cash flows, and product market fit. Look for the growth potential of the company. Points to be considered for a beginner while investing in IPOs.
5 golden rules about the IPO for beginners
- Read as much about the company from news, from analysts, and from websites or blogs, and forums which are providing in-depth analysis about the company coming with IPO.
- Do not just look for the subscription date of the IPO, understand the company.
- Understand the financial performance of the company, its debt position, its products, and its competition before investing in the IPO.
- Do not go with the IPO GMP or IPO grey market premium. This does give an idea about the performance of the IPO in the long term.
- Do not look for short-term gain as a beginner.
- Look for the documents like DRHP, RHP, and other financial statements of the company. They are freely available with SEBI and BSE.
Applying or investing in IPO online
Buying an IPO is a little easier with technology on your side. Typically, you would have to buy IPO stock through your stock broker. But if you understand the company well and want to apply for the IPO directly, there are many ways you can do it.
Investing in IPO online is little easier for tech savvy investors. Brokers like Zerodha, Upstox, and 5Paisa are offering access to IPOs. Retail investors can directly apply for the initial public offering through these brokers. All you need is to have a Demat account with these brokers. In some cases, you may need to meet certain eligibility requirements, such as a minimum account value or a certain number of trades transacted within a certain time frame.
Nationalized banks are also offering options to apply for IPO through ASBA. You need to have a Demat account in any broker or bank and a saving account in the bank linked with the Demat account. Once you log in to your saving account, like SBI, ICICI, or HDFC bank, find out the equity option and fill out the detail form for the first time to link your Demat account. It becomes a smooth process for applying or investing in IPO online after that.
However, through investing in IPO online is easier, you still have to do your research and due diligence before investing in a company at its IPO. The best way to invest in IPOs for beginners is to follow the 5 golden rules about IPO for beginners to succeed in your IPO investment journey. Keep an alert in mind2markets.com for an in-depth analysis of any company coming with an IPO.
More from across our site
We endeavor to help you to understand different aspects of a company before you invest in the company’s IPO. To know more information about business overview of each company, here are some suggested readings on company insights BIBA Fashion Limited IPO, SSKL IPO, Mankind Pharma IPO, Upcoming IPOs Review. IPO Companies.