Investing in an Initial Public Offering (IPO), during which a company offers fresh shares for sale, is a tricky business. As much as an IPO promises a windfall to investors, it is also rife with risks. Those with deep pockets can bear the shock but retail investors may find it difficult to manage losses if the market decides to swallow their investments. It is thus important that retail investors practice utmost caution when deciding whether to invest or stay away from an IPO. But how do you do that? What are the key points that every retail investor should keep in mind during an IPO?
First, let's understand who is a retail investor.
A retail investor is a non-professional investor who cannot apply or bid for shares worth more than Rs 2 lakh. Given their low purchasing power, these investors often trade in lower amounts compared with institutional investors. They often have to pay a higher fee for their transactions.
Now, the factors that retail investors should keep in mind while investing in an IPO.
1. Due Diligence
All listed companies are bound by regulations to publicly divulge information that may affect their stock prices. But a company going for an IPO is not listed, making it difficult for investors to get information about it. Investors should make every effort to learn about a company's financial ability, past record, and promoters before applying to buy its shares.
2. Focus On The Fundamentals
Analyse the fundamentals of a company going to be listed on an exchange for the first time by comparing it to those leading the segment it operates in. For example: look for the medium-to-long term growth potential of the sector. Compare its potential with respect to its competitors. This will give you a fair assessment of the price of the IPO stock whether it is undervalued, overvalued, or just right.
3. Read The Prospectus
Every company going for an IPO has a draft red herring prospectus (DHRP). This document contains various details about the company – such as its financial standing, its performance so far, its promoters, and its competition. While this document has a lot of information about the company, it is nonetheless prepared by the company. So, verify.
4. Institutional Investor Interest
Retail buyers should always check how interested institutional investors appear in an IPO. That would give them a hint of how secure or risky the investment would be. A greater institutional buyer interest may suggest market confidence in the IPO. But retail investors are advised to make their own decisions irrespective of those whose motives are not known to them.
5. Investment goal
Ask yourself what you want to achieve with a particular investment. Once your goals are clear, you can then compare whether an IPO fulfills them or not and decide accordingly.