When a privately-owned company, for the very first time, offers to sell its shares to the public, for money it's called an Initial Public Offering (IPO). The privately-owned company does this by listing their shares on the stock market and offer them to the general public.
Usually the proceeds from the sale of shares (public issues) can be used for various purposes.
Maybe the company's wants to expand, or enter new markets.
Maybe they need it to launch new products or simply attract fresh talent.
'My one recommendation is that all investors should be wary of new issues (IPOs).'-Benjamin Graham, the father of value investing.
Unfortunately, most investors base their investment decisions on hearsay and rumours which is like gambling away their savings in a game of poker. When it comes to investing, it's always wise to base your decision on independent research.
So where can an investor avail information on a new company?
Before the company launched the IPO they publish a lengthy document containing information about the company. Its ownership, management details, core business, customers, risks, use of proceeds from the IPO etc.
Browsing through it can get cumbersome.
The key is to focus on certain factors and analyse them.
Business - age, nature and profitability of the core business?
Is the business profitable? Atleast at the operating margin level?
Asian Paints Ltd. and Tata Consultancy Services, one of the greatest companies in the Indian stock market, had a track-record of profits before launching its IPO. Look at DishTV, it wasn't profitable for the longest time and has lost more than 70% of its stock value.
How long has it been operational for? Often IPOs have new business models owing to continuous innovation in the industry; mobile operators, internet companies, digital entertainment companies etc.
Its best to completely avoid businesses that are yet to start-up or are unproven.
Also, Avoid businesses that are cyclical in nature. Mainly because they will issue public equity their when their business is thriving to raise the maximum amount of money. This can be detrimental to the investor.
Management competency? Do they have independent board?
Evaluate the top management - CEO, CFO and COO. Do they have a compelling vision? Kind of business philosophy they have adopted? Do a quick background check. Read up on their qualifications and work experience.
Moreover, try to access if the company is entirely dependent on the CEO or have they formed a management team. Look at Infosys Ltd. They had a team of top level managers and each one of them was a well-known face of the company over time - Narayan Murthy, Nandan Nilekani, N. S. Raghavan, S. Gopalakrishnan, S. D. Shibulal.
Additionally, it is very important to analyse the Board of Directors. A large percent, preferably more than 50% of them should be entirely independent (not related to the owner of the company). And it's even better if they have work experience in other publicly listed reputable firms.
Ratios – peer comparative analysis
Evaluate the company's balance sheet and income statement in isolation can be fruitless. Moreover, Financials alone can be overwhelming. Derive and focus on some ratios like, profitability ratios, return ratios, Liquidity ratios, debt-equity ratios, Price/Earnings, Price/Sales. Notice the trends. For instance, Spikes in account receivables is red flag.
Compare them with their relevant peers. Most of them will have a publicly listed peer companies.
This will help decipher is the company is over or undervalued.
Debt laden – will the investors’ money go towards repayment alone?
If the company' balance sheet is riddled with a large total debt it might not be worth your while. Mainly because a large portion of the proceeds from the IPO (or money raised) might be used to repay the debt. As a result, there won't be much left for the company to grow and generate higher returns for the investor. Evaluate the need for money or whether it's been used to pay off the insiders.
Ownership - is it owned by an established and clean business house?
If a company has the backing of a well-known and established business house that has always worked towards creating wealth for the investor. For instance, Godrej Industries, HDFC Ltd and HDFC Bank have always been focussed towards their investors and worked towards profitability. Hence one can consider IPOs from these business houses; HDFC Life, Godrej Agrovet etc.
Other large Investors – have institutional investors invested? Are any of the institutional investors exiting the company?
If you see that large well-known fund houses or institutional buyers are some of the investors in the company, consider it. If they are good enough for professional money managers they can be good enough for individual investors.
If the private equity or large institutional investors are exiting it indicates that they don't think the company will grow substantially. They probably have better opportunities and don't believe in the company's future prospects.
Don't just consider one of the factors. They have to be looked at in wholesome. Take DishTV for instance, even though the promoter family has created has given us companies like ZeeTV, DishTV effectively has destroyed investor wealth since its listing.
Remember, IPOs like any other investment carry risk. Use your knowledge as a consumer. Do your independent research. Focus on the key factors mentioned above. Keep in mind, a well-informed investor equals a successful investor.