Five Minutes to Understanding IPOs

Why buy an IPO and not through the secondary market?

With an IPO you get a shot at buying a tree when it is just a sapling. A fully grown apple tree may cost Rs 500. But an apple sapling may cost Rs 5. A half-grown apple tree that is yet to bear fruit may cost Rs 100. By buying a sapling whose value may grow to Rs 500, you are buying cheap today something that maybe of value tomorrow. You may even be buying seeds from an existing fruit-bearing tree. But you need to have some knowledge of apple trees, horticulture and apple markets before you can identify a sapling with potential. IPOs are the same. You have a chance to part-own a business before it has fully grown or in a grown company’s expansion plans. Investors who saw the potential of Infosys or Satyam and bought little saplings, now own fully grown fruit-bearing trees.

What to look for in an IPO

You need to filter out the hype from the offer and go for a company whose business you understand. Don’t buy a telecom company if all you know about telecom is how to use a mobile. Look at the company making the offer and its track record in terms of performance in the last three years. Look for a strong professional board of directors. Analyse the status of the project – is it fully operational or half completed. Read the risk factors (both internal and external) in the offer document. Consult your financial advisor or broker if you have any doubts. The company should follow good corporate governance norms and offer transparency in their operations. The market regulator has tightened the norms governing IPOs and put stringent entry barriers to companies entering the market, yet, do your due diligence before you buy.