Investing through Initial Public Offering (IPO) is the simplest form of investing in equity. There are only few things you have to check, and risk of losing is very less.
But yes, it is not risk free, many times stocks get listed at discount and you may lose money. But the chances of making money through IPO is higher.
What can a shareholder do if he or she wishes to let go of the shares in hand?
This is particularly more troublesome in a private company due to the limited options available: (i) Sell to another person he/she is familiar with; (ii) Sell to other shareholders of the company; (iii) Withdraw from the company (which requires consent from all shareholders)
What is a public listing?
It means making company shares tradable in an open market. This particular shareholder would then be able to sell his or her share to the public easily.
List the shares to sell, then wait for the public to buy from you. How easy could it be? The company to be publicly listed would first issue new shares for subscription by the public.
It is also a fundraising exercise from an external source, with the difference that you make it open for public.
2.0 WHAT IS AN IPO?
A company consists of three core aspects: Shareholders, Board of Directors (BoD), and the Management. The company could, at one point of a time, consider expanding their business, which in turn requires more money.
The management could utilise internal funds, apply for a bank loan, or ask shareholders to pour more cash into the company. Companies can also raise funds from external sources, such as someone companies are familiar with, a private equity fund, or even crowdfunding.
When a company raises funds by issuing new shares or debentures for sale to the public, it is called a public issue, or an IPO.
A company which is not already listed on any stock exchange makes its debut on the stock markets through IPO.
A good IPO is a best instrument for short gain (listing gains) as well as entry point for long positions.
An IPO is the first time any private or public company puts up its shares on the stock market.
One advantage of an IPO over other forms of investment is that it promises huge returns on minimal initial capital.
IPOs are performed by private or public companies that are not yet listed on the stock market.
3.0 WHY IPOs ARE PROFITABLE?
Public issues provide you with an opportunity for picking up shares at relatively low prices.
Newly formed companies usually offer their shares for subscription at par values, whereas existing companies price their new issues at levels which are sometimes as much as 20 to 30 per cent lower than the market price of their existing shares.
For example, new issues priced at $12 to $15 per share may be quoted as high as $20 to $25 per share in the secondary market soon after their listing on the bourses.
Similarly, shares issued at par by new companies also quote at high premiums soon after they get listed on the stock exchange.
This is the main reason why public issues are so popular with investors; they offer opportunities for making quick money which few other forms of investment can hope to match, match particularly during the market’s bull phase.
4.0 HOW DO WE MAKE MONEY OUT OF IPOs?
The easiest way to make money out of IPOs is to sell them on the first day of listing.
Do note that the market price of an IPO share is likely to be higher than the IPO issue price.
Many investors dream about the fortunes to be made by getting in early on an IPO but knowing which stock will make money in the months following an initial offering is trickier than it may seem.
Unsophisticated investors face the risk of losing money in the first few years after an IPO.
When a company decides to go from private to public with an IPO, there’s an opportunity to make money if the stock value rises on the first day of trading and in the months and years that follow.
IPO investors who are looking for a very quick return are known as flippers because they hope to buy and sell on the first day of trading.
Long-term investors are more interested in IPO shares that increase steadily over time.
If you’re planning on investing in an IPO, you should decide which kind of investor you want to be.
5.0 GUIDELINES FOR INVESTING IN IPOs
New issues can be divided into two broad groups: (i) New issues of newly formed companies, and (ii) New issues of existing companies.
New issues of existing companies are, by and large, very good investments. They provide an opportunity for acquiring shares in ongoing profit-making companies at relatively low prices.
On the other hand, all new issues of newly formed companies may not be good investments and you should be careful in selecting them to invest in.
Find below some guidelines, which should help you select the right new issues for investment:
- Don’t invest blindly in a company having unknown and untried promoters. First study the performance of other companies set up by the same promoters.
- Don’t invest in a company, which is not ready to start business operations and have long gestation periods before business operation can commence.
- Invest in companies that have something new to offer. Companies introducing a new product or industrial process for the first time, companies proposing to manufacture a product which is currently being imported, companies introducing a technologically advanced or better quality product, or companies venturing into new areas are likely to be better and more remunerative investments.
- Invest in companies that operate in high-growth sectors of the economy.
- Avoid investing in very small companies.
- Companies where the foreign collaborator has an equity stake are often good investments. Foreign collaborators do not readily opt for an equity stake in any company unless they are confident of its bright future prospects.
- Do apply for the mega issues of well-known profit-earning companies. The sheer size of such issues ensures better chances of getting a firm allotment. The bigger the size of the issue, the better will be your chances of getting a firm allotment.
By subscribing to an IPO, the public are given an opportunity to become a shareholder of the company at a relatively lower price and less demand to cash in hand.
Some investors who had bought stock at the IPO price have been rewarded handsomely. The only snag lies in getting a firm allotment of shares.
Since most good public issues are heavily oversubscribed, lots have to be drawn and only a few of the applicants succeed in getting a firm allotment.
Sometimes the allotment is done on a proportionate basis.
Therefore, you should consider yourself lucky if you get an allotment of even a small number of shares. It is with this background in mind that you should calculate the pros and cons of applying for IPOs.
Categories: MUTUAL FUND, IPO AND EQUITY SHARES