Red flags you should not ignore before subscribing to an IPO

By Mr. Amarjeet Maurya – AVP – Mid Caps, Angel One Ltd

The IPO frenzy in India has taken the stock market by storm in 2021. The market is crammed with companies waiting to raise funds with public offerings. This year has been extra special as we witnessed new-age technology startups like Zomato, Paytm, Nykaa, etc., hitting the market. While some succeeded, others failed to perform well in the market despite the hype. In these 11 busy months in the IPO market, 53 IPOs (including 1 REIT and 1 INVIT) collected a total of Rs.114,653cr this year. There are companies ranging from new-age startups to well-established brands lining up in the IPO market in the coming future. We will soon see companies like Adani Wilmar, Keventer Agro, LIC, PharmEasy and Go Airlines, among others going public.  

Given the popularity of IPOs among retail investors in the market, it becomes crucial to understand the red and green flags to consider before investing in an IPO. Investors, especially GenZ and millennials, need to realise that just because the company name is well known in the market doesn’t mean it is worth investing in. There are numerous factors that can make the company worthy or unworthy of investment or not. One doesn’t have to give in to FOMO (fear of missing out) when investing in the capital market. 

Instead, you can undertake your research on the company basis the given points and take into account the red flags:

Business model 

Before you decide to invest in the IPO of a company, you need to analyse its business model as part of your research. The investor has to understand how the company is generating revenue and its cost structure. One has to consider the company’s core strategy for doing business profitably and its competitive advantage in the market. You also must understand its products and services. Other levers are pricing and costs. If the company seems good based on its business model, then you must continue your research to know it better.

Historical financial track record

The following important factor while evaluating whether to invest in a business or not is its historical financial performance. You have to see whether the company has been churning out profits in the last five-six years or not, whether it’s making growth in its sales or not. Profits and growth indicate that the company is stable. Thus, if you are buying an IPO of that company, it means you will also be able to make a profit. But suppose in the past five years, the company has been inconsistent with its profit and growth. In that case, it doesn’t make much sense to invest in it as the numbers show inconsistency, and you can’t rely on inconsistent numbers for profitability.   

Management

After you have analysed its business model and historical track record, you may also want to look at its management. Take a close look at the people running the company, including the promoters and the company’s management team. You will have to see whether these people have enough experience to run the business or not. It’s also important to assess that the company is credible and there is no history of scams or litigation cases.

Valuation

Once you have checked the business model, history, and management of the company, it is time to see its valuation. There are a lot of valuation methods like Price to Earnings (PE), Enterprise value-to-sales (EV/sales), Price to Value, etc.  It helps in comparing the value of the company with its peers. For instance, the PE of the FMCG company is 45X average and if the company going public is asking for 50 PE, then there’s no upside for the investor. If PE is 40, there’s a scope of growth and profit for the investor. However, apart from valuation, we also have to see growth. The growth factor also decides valuation.

Conclusion

Investing in IPOs can be a tricky business, and if investors are not mindful, then following a trend may result in losses. Given that India’s retail investors are young and new to the capital market, they must understand what it means to invest in an IPO. Doing a bit of your research can take an investor towards making profits in the market.