A Beginner's Guide on How to Invest in IPO.

Investors who want early access to shares of companies which have the potential to perform well may prefer Initial Public Offering (IPO) investments. However, new investors may get confused regarding the evaluation and application process of an IPO. This article offers a complete guide to IPOs and discusses the steps beginners can follow while investing in an IPO. 

What is an IPO?

An Initial Public Offering, or IPO, is a process through which a private firm offers its shares to the general public for the first time. It allows the firm to raise capital and to list on a stock exchange. Once listed, the shares can be openly traded by the investors through investment platforms offered by brokers.  

Firms can go public to raise capital to grow, reduce debt, enhance brand awareness, or enable early investors to cash out. An IPO also provides the firm with easier access to capital markets in the future. 

IPO Guide for Beginner Investors

First time investors in IPO can follow these steps to learn more about a company's IPO and whether they should invest. 

Step 1: Read the Draft Red Herring Prospectus (DRHP) 

The DRHP contains information about the company’s financials, business overview, risks, and how the capital will be spent. 

Step 2: Analyse the Company’s Fundamentals 

Research about the company’s revenue, profit growth, debt, business model, and competitive strength. 

Step 3: Evaluate the IPO Valuation 

Compare the P/E ratio of the company and other ratios with its listed peers to assess whether the price band is reasonable. 

Step 4: Confirm the Promoters' Background 

Experienced and trustworthy promoters may help the company perform better after the IPO. 

Step 5: Research the Market Conditions 

If the overall market sentiment is not favourable, an IPO may not perform well in the short run. 

Step 6: Use the ASBA Facility 

Always apply through Application Supported by Blocked Amount (ASBA) so that funds are retained in your account until allotment. 

Step 7: Be Cautious of Grey Market Premium (GMP) 

Though GMP can be an indicator of demand, it is an unofficial measure and should never be the sole factor in decision-making. 

Note: IPO investing is not deterministic, always do thorough evaluation before investing. 

Advantages of Investing in an IPO

Below are some potential advantages of IPO investment for beginners: 

• Early Investment Opportunity: Early investment in firms with potential for expansion. 

• Listing Gains: Stock prices may rise after listing, depending on demand and fundamentals. 

• Transparency: IPO-bound firms have to disclose their finances. Reviewing these financials can enhance decision-making. 

• Portfolio Diversification: IPOs provide exposure to companies or industries not previously available in the market. 

Risks Associated with IPO Investment

While there are advantages, the potential risk associated with IPOs must be considered. 

• No Past Data: The absence of historical listing data makes it challenging to predict share performance following their listing. 

• Overvaluation Risk: In certain instances, the price of the offering may be higher than justified. 

• Market Volatility: General market conditions can influence IPO performance regardless of the company's fundamentals. 

• Limited Allotment: Overwhelming demand can lead to partial or zero allotment. 

How to Apply for an IPO

Here's a step-by-step method of applying for an IPO. 

Step 1: Demat and Trading Account:  

You need to open both trading account and demat accounts to hold and sell shares after listing. 

Step 2: Access your Broker Platform 

Utilise the website or mobile app provided by your stockbroker. 

Step 3: Choose IPO from List 

Choose the IPO you want to apply for. 

Step 4: Enter Bid Details 

Input details such as quantity and price (or select cut-off). 

 Step 5: Select UPI/ASBA 

Make payment using the UPI or ASBA facility. 

Step 6: Submit Application 

Accept your bid and wait for allotment status. 

Common Mistakes to Avoid While Investing in an IPO

While investing in IPOs, investors must avoid mistakes such as: 

1. Investing Without Reading the DRHP 

The Draft Red Herring Prospectus (DRHP) provides crucial details about the company’s financials, risks, and future plans. Avoiding it may lead to inappropriate decisions and potentially higher investment risk. 

2. Relying Only on Increased Demand or GMP 

Grey Market Premium (GMP) does not guarantee long-term performance of the stock. Depending only on demand-based trends can mislead investors and may lead to losses. 

3. Submitting Bids for Several Lots 

Investors may assume that applying for multiple lots ensures allotment, but IPO allocation follows a set process. Overbidding may unnecessarily block funds without improving the chances of allotment. 

4. Ignoring Risk Factors and the Business Model 

Every company has unique risks linked to its sector and operations. Investors cannot properly assess whether the business is sustainable in the long run if they overlook these aspects. 

Conclusion

Investing in IPOs may be a potential investment opportunity for investors. However, before investing, individuals must read the DRHP, analyse the company’s fundamentals, check investor sentiment for the IPO and analyse the prevailing market conditions. Knowing the steps of investing in an IPO and the errors to avoid helps you make informed investment decisions.