Understanding IPOs: Do You Invest or Not?

Investing in the share market is one of the most popular methods of increasing your money. Periodically, you may come to know that a company is going to offer its IPO and everyone is hurriedly putting their money into it. But do you know what an IPO is, and whether you should invest in an IPO or not? Let's get to know everything in simple words.

What is an IPO?

IPO stands for Initial Public Offering. It is for the first time that the share of a private company is offered to the public.

Prior to the IPO, the company belongs to its founders, promoters, and some private investors. Post-IPO, the company gets listed in the stock market, e.g., NSE or BSE in India.

As the company expands and requires additional funds to further develop its business, construct new products, or pay off debt, it can obtain money from the public by offering its shares. In exchange, the individuals purchasing these shares become shareholders of the company.

In brief:

An IPO is the method through which a private company transforms into a public company by issuing its shares publicly for the initial time.

Why Do Businesses Issue IPOs?

There are various reasons why a firm chooses to go public:

To Raise Capital for Growth: Businesses require finances to expand, establish new offices, purchase equipment, or finance new ventures.
To Retire Debt: Certain companies employ the funds raised through an IPO to pay off previous loans or lighten their liabilities.
To Enhance Reputation and Confidence: When a business goes public, it receives greater publicity, openness, and credibility in the marketplace.
To Provide Exit Route to Early Investors: Early investors or promoters may offer the public a portion of their holding and cash in.
To Enhance Brand Value: Listing with the stock exchange provides the company broad publicity and media exposure.

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Types of IPOs

There are primarily two types of IPOs:

1. Fixed Price IPO: In a fixed price IPO, the price of the shares of the company is fixed by the company. The price is known to the investors when they make an application.

For instance, if an IPO price is fixed at ₹100 per share, all the investors will purchase it at that price.

2. Book Building IPO: In a book building IPO, the company offers a price range (say ₹90 to ₹100). Investors bid within this range. Once the bidding is closed, the price is determined by demand.

A majority of contemporary IPOs are book building IPOs, as they enable the company to know the true market demand.

Other Terminologies used in IPOs

Offer for Sale (OFS): Here, already existing shareholders (such as promoters or private shareholders) offer their shares to the general public. The company does not receive this money - the sellers take it.
Fresh Issue: In this situation, the company issues new shares to get new money for its business or growth.
SME IPO: These are IPOs brought out by Small and Medium Enterprises (SMEs). They have smaller issue sizes and slightly different listing regulations.

What is GMP (Grey Market Premium)?

GMP is an abbreviation for Grey Market Premium. It represents the additional price individuals are willing to pay for an IPO stock in the off-market before it lists on the stock exchange.

Example: Suppose an IPO is priced by the company at Rs 100 and individuals are selling it off-market at Rs 120 before listing, then the GMP is Rs 20.

A higher GMP tends to indicate that individuals hope for the stock to list at a more expensive price. This is not official or guaranteed, though. The grey market is not regulated and purely speculative, so do not make your choice based solely on GMP.

Read Also: Should You Invest in SME IPOs? Truth Every Investor Must Know!

What is Market Value?

Market Value, or Market Capitalization, indicates the total worth of an organization in the stock market.

It is computed as:

Market Value = Current Share Price × Total Number of Shares

For instance, if a company has 10 crore shares and the share price is Rs 100 each, then the market value is Rs 1,000 crore.

Market value assists investors in comparing companies of varying sizes and whether a company is large or worth a lot after listing.

Understanding Company Fundamentals

Prior to investing in any IPO, one should know the fundamentals of the company — its actual financial health and future potential.

The following are the primary things to be verified:

Revenue and Profit: Take a look at whether the company is earning profits and whether its revenue (sales) is growing annually. A consistent company with rising profits is a good sign.
Debt Level: Check how much debt the firm has. A firm with excessive debt may have problems in difficult times. Low debt is generally preferable.
Cash Flow: Paper profits are not sufficient — the firm must have positive cash flow, i.e., actually receive money from operations.
Promoter Background: Find out about the promoters and management of the company. Are they seasoned ones? Do they have a good reputation? Have they experienced any legal or financial problems?
Utilization of IPO Proceeds: See where the firm intends to utilize the funds raised through the IPO — expansion, repayment of loans, or other objectives. It must have a well-defined and robust reason.
Industry Outlook: Observe the industry in which the company is working. Is it expanding or declining? For instance, technology and alternative energy industries are expanding more rapidly than conventional ones.
Competition: Compare the company with its competitors. Does the company possess any unique advantage (such as a special product, superior price, or huge customer base)?
Valuation: Occasionally, firms overprice their IPOs. You can use the company's P/E (Price-to-Earnings) ratio and compare it with that of similar listed companies to determine whether it is reasonable or costly.

How Does the IPO Process Work?

Here is how an IPO typically occurs step by step:

Filing with Regulator: The firm submits documents with the market regulator (such as SEBI) to seek approval for its IPO.
Price Announcement: The price range (for book building) or the fixed price is determined by the company and its bankers.
Opening for Bidding: Investors can bid for the IPO during the open period (typically 3–5 days).
Allotment of Shares: Once the bidding ends, the company determines who receives how many shares. If more individuals apply than are available shares (oversubscription), allotment occurs through a lottery system.
Listing on Stock Exchange: The shares begin trading on the exchange on listing day. The price can rise or fall depending on market demand.

Benefits of Investing in IPOs

Opportunity of Listing Gains Most IPOs list higher on listing day, providing immediate profit to early sellers.
Early Entry into a Good Company Purchasing during the IPO stage makes you a first-time shareholder. In case the company does well, you can reap enormous long-term gains.
Transparent Process IPO information such as price, financial reports, and goals are made public, enabling investors to make sound decisions.
Portfolio Diversification You have the ability to invest in new and developing firms in your portfolio, maintaining risk and return balance.
Easy Access for Retail Investors Anyone having a Demat account can bid for IPOs simply through online portals.

Risks Involved in Investing in IPOs

Overpricing There are occasions when firms price very high, unsupported by either their profits or performance. Such IPOs tend to dip after listing.
Volatility IPO shares can be extremely volatile during the initial weeks of trading.
Hype and Speculation Most investors apply because of market hype or social media craze, and not due to actual study.
No Allotment If an IPO is oversubscribed, nobody receives shares. You could receive no allotment whatsoever.
Limited Track Record New businesses might not possess sufficient historical financial information to evaluate their stability and performance.

Tips Before Investing in an IPO

Following are some helpful tips for new investors:

Read the Company's Prospectus Carefully.
It has crucial information regarding business, risk factors, and utilization of funds.
Check Fundamentals, Not Just GMP.
GMP can fluctuate rapidly; pay more attention to actual financial figures.
Compare with Similar Listed Companies.
This will give you an idea whether the IPO price is reasonable.
Avoid Herd Mentality.
Don't do it just because everyone is doing it.
Choose Your Object.
Do you want to invest for listing returns (short term) or long-term appreciation? Make up your mind beforehand.
Invest Only What You Can Afford to Lose.
Never invest money you borrowed or your rainy day money.
Be Patient.
Even if you receive the allotment, wait a couple of quarters to observe how well the company is doing.

Should You Invest or Not?

The last question: Should you invest in IPOs or not?

There is no one-size-fits-all answer. IPOs are fine if you invest sensibly following due research, but they can result in losses if you go by hype.

You Should Think of Investing If:

The business has good financial performance and minimal debt.
The industry is developing with excellent future prospects.
The IPO price appears reasonable based on peer companies.
You are willing to assume moderate risk and hold for long periods.

You Should Avoid Investing If:

The IPO is overpriced and overhyped.
The profits of the company are unstable or negative.
The company management lacks experience or has a negative reputation.
You are seeking merely short-term listing returns.

In simple words - invest only if you know the company, its business, and the risks. Don't invest blindly because everyone's hyping about it.

Disclaimer: The facts presented in this article are for educational and information purposes only. It should not be considered investment or financial advice. Investment in IPOs or the stock market is subject to risk, including potential loss of capital. Investors are advised to conduct their own due diligence or seek the advice of a competent investment advisor before they make a purchase decision. The writer and site disclaim any financial loss or damages resulting from investment decisions made based on this material. Past performances or trends (such as GMP) are no guarantee of future performance.