8 musts for investing in IPOs

Among the many records created by the Indian stock markets during the year 2004, another record that was too much in the limelight was that of the initial public offer market.

It was a record as the Indian capital markets saw over Rs 30,500 crore (Rs 305 billion) being raised from the primary market, the highest ever.

This achievement gets further magnified when compared to the fact that this amount was almost 14 times higher than that of 2003 {Rs 2200 crore (Rs 22 billion)} and just a tad lower to the near Rs 32,000 crore (Rs 320 billion) raised by IPOs in the period 1995-2003 i.e. 9 years! And, as per reports, if the IPOs lined up for offering in 2005 are considered, 2005 could be, once again, a record breaking year for the IPO market.

Before we go on to how an investor should look at an IPO, consider some of the stocks' performance that got listed in the current fiscal (FY05) to date.

With the kind of gains most of these IPOs have returned, investors seemingly have good enough a reason to invest in the upcoming IPOs. However, before jumping to any conclusion it is pertinent to remember that in a little over a decade, as per the numbers available from the Ministry of Company Affairs website, 115 companies have vanished after raising money from equity markets! The aggregate size of all these issues combined stand at over Rs 80 crore (Rs 8 billion)!

Indian stockmarkets have been in the grip of bulls since the last couple of years, one of the key reasons why the IPO activity has heightened significantly in recent times. It must be noted that during such times, an unlisted company would not only be able to realise a good valuation for its offering but would also be rather sure that its issue would be 'over-subscribed' considering the high appetite amongst investors -- both domestic and foreign -- to invest in equities.

However, investors must note that investing in an IPO is not just about listing gains (termed as 'flipping'). In fact it is like any other equity investment where fundamentals (should) rule the roost. While an investor may earn mind-boggling returns in many of the IPOs, it is equally possible that he might be amongst those who were unfortunate enough to have invested in the IPO of a company, which vanished with the money later.

Thus, all the factors that are considered while investing in an already listed company would be applicable while choosing to invest in an IPO. In fact, much more caution is advised in IPOs considering the fact that most of them do not provide their financial history beyond what is made mandatory by the regulators. And as such, investors must do their homework with even more sincerity. We have re-produced below some of the parameters that investors should bear in mind while investing in an IPO.

• Who are the lead managers to the issue? Do lead managers act as an indicator of the quality of the issue?
• What is the promoter holding in the company? Is there any participation from financial institutions or a venture capital firm?
• Where is the company investing the money?
• Which sector does the company operate in? What is the growth prospect of the company vis-à-vis the sector?
• Do the promoters have enough experience?
• Will the money invested yield maximum returns? Are the profit projections achievable?
• How do I justify the price of the issue?
• Does the company enjoy tax benefits?

Equitymaster.com is one of India's premier finance portals. The web site offers a user-friendly portfolio tracker, a weekly buy/sell recommendation service and research reports on India's top companies.