Should you invest in IPOs for long term? Know how to determine

In 2021 so far, 57 companies have made their stock market debut raising more than Rs 1.1 lakh crore so far.

An Initial Public Offering (IPO) is one of the ways to enter the equity market. However, before its listing, the issue price of an IPO is calculated manually, by taking into consideration various factors that affect the pricing of the public issue of the shares of the concerned company.

“IPO’s have been the new thrill in the market, garnering public attention like never before. Generally, a booming stock market often provides the ground for a rise in IPOs. In 2021 so far, 57 companies have made their stock market debut raising more than Rs 1.1 lakh crore so far! This frenzy sees no stopping with a number of more issues lined up for this month,” said Nitin Mathur, CEO, Tavaga Advisory Services.

As there are misconceptions that before listings, the share prices of companies are generally available at a cheaper rate than the price after listing, many people try to take advantage.

“A common perception in everyone’s mind is that IPO’s are meant for short-term gains and that they do not generate investor returns over a longer term,” said Mathur.

However, equities are meant for long-term investments and the quest to earn short-term gains on IPOs may backfire, in case of overvaluation of an IPO.

“Well, this is true but to an extent. About half of the IPOs in the last 10 years have generated negative returns! We all know the fate of some of the hyped IPOs in the past like Reliance Power, DLF, Jaypee Infratech. So why so much hype around them after all? Most investors get lured to IPOs because of excessive optimism about the company and the new-age sectors they belong to. Social media and excessive liquidity have simply added to this euphoria resulting in mountain high valuations at which these IPOs get listed.Thus, when the euphoria around them dies down, most of these companies tend to underperform as they fail to live up to the market expectations,” said Mathur.

In case of undervaluation, however, an IPO may provide a lucrative option to earn some quick returns.

“Having said that, not all IPOs are bad. About one–fourth of the IPOs since 2010 have also turned out to be multi-baggers, i.e. generating more than 100 per cent returns from their listing date. Jubilant Foods, Persistent systems to name a few. Thus, investors should carefully evaluate the IPOs on a case-to-case basis before investing. Some of the factors like a sustainable business model, strong fundamentals, growth potential, quality of promoters, justified valuations, etc. should be considered before investing in IPOs for long-term investment. Investors with a longer time horizon should avoid making investment decisions simply based on market hype,” said Mathur.

For long-term investment in an IPO, investors should become absolutely certain about sustainability of the concerned company, before taking a decision to invest.

“A company with a sustainable business model, strong fundamentals, reasonable valuation, quality of promoter/management and growth prospects determine the longevity of investor interest. For fundamentally sound companies, investors should not worry about listing gains/loss. Investing in IPOs for the long term makes sense only when you believe in the long run growth potential of the company,” said Neha Khanna, Director, ValPro.

For long term IPO investing, according to Khanna, investors can check the following:

(1) Understanding the business and the Growth Potential – recognising the market opportunity and the company’s capacity to capture the market share can be an important criteria to decide. Companies with high-growth potential will be able to generate regular profits and increase its revenue.

(2) How the company is going to use the proceeds – just for debt repayment or to expand the business.

(3) Promoter background and management team: An investor should closely check who is running the company. The company’s management is responsible for driving it ahead.

(4) Financial performance of the company needs to be evaluated to check whether its revenues and profits are growing or falling over the past few years.

(5) Investors should closely identify the peers of the company and evaluate the comparative valuations to identify if the company’s valuations are in line with its peers or not.

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