InvestorQ : How do I evaluate if an IPO is good for investing or not? I am asking because most IPOs appear to have done very well in the last one year but I missed out.
Rutuja Nigam made post

How do I evaluate if an IPO is good for investing or not? I am asking because most IPOs appear to have done very well in the last one year but I missed out.

Answer
user profile image
Arti Chavan answered.
11 months ago


There are not hard and fast rules for a good IPO but you can surely apply these six basic ideas to distil good IPOs. That could have probably helped you out in the last one year.

· Given a choice, always prefer a focused business model over a diversified business model. Here is why. Companies that are into multiple businesses tend to be viewed as a holding company and therefore they tend to quote at discount valuations. Avoid putting money into IPOs that are into multifarious businesses. Focus on IPO that are staying close to their core competence and are not spreading their business too thin.

· In case of an OFS, check if all the anchor investors are exiting the company en masse. Anchor investors would have already invested in these companies at an early stage. Anchor investors are brought on board by invitation to give a boost to the stock’s credibility. They also give an indication of the institutional interest in a stock. While anchor investors cashing out in an OFS is understandable, prefer companies where the anchor investors are staying put in the company, at least partially.

· Be wary of IIPOs where the promoter is exiting as part of an offer for sale? Here again, some monetization is understandable but a big fall in holding is not and can raise a question mark over the issue. As an IPO investor you must check if the promoter group is exiting the company in a big way through the IPO. It is always advisable to be cautious about such issues.

· Be cautious if the IPO is going to be very dilutive. When the IPO is dilutive, then the EPS suffers and eventually the valuation also suffers. Ideally, the best IPOs are the ones where the capital base is small and the dilution is minimal. That is when the value creation actually shows up in a smart way on the stock price.

· Spend time on the financial projections and check if they are way too aggressive? Also make it a point to check the usage of funds of the IPO; Capital assets, loan repayment or working capital. Be cautious of IPOs where the funds will be used for working capital or for repaying short term loans or for acquisition of real estate. These are not value accretive.

· Finally, look at the GMD combination. This is largely akin to investing in the secondary markets after all it is equities that you are buying. GMD refers to (Growth, Margins and Debt). Firstly, convince yourself that the company operates in an industry that has growth potential over the next 5 years. You don’t want to be stuck in an IPO that is going to stagnate. Secondly, look at the flow and stock margins. Are the net profit margins and ROE comparable with peers in the industry? Many IPOs will try to sell the eyeball story, but you need not fall for it. Focus on hard profits. Lastly, is the company too indebted? You do not want solvency issues. Look at the debt / equity ratio and the debt coverage ratios.