- Wealth PMS (50L+)
There are lots of new Initial Public Offers (IPOs) that have failed in the market such as:
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All IPOs must file their offer documents earlier with the NSE and BSE and you can download them online. If you read some of the offer documents you will be in a better position to evaluate an IPO for investment.
So what are the things you should look for in an IPO offer document?
1. P/E: Absolute and Relative
The Price to Earnings ration (P/E) is very important to understand. It’s the price of the share (the value at which you buy it) divided by the Earnings Per Share (EPS). EPS, in turn, is the NET PROFIT of the company divided by the total shares of the company.
But P/E is important to consider AFTER the issue: I.E. don’t consider the no. of shares given in the offer document in the results – those are usually the “past” number of shares. For example, GMR recently has gone for an IPO for 3.3 crore shares, but it’s past results show the shareholding as 30 crore shares. After the IPO, the total number of shares is 33 crore, not 30 crore! So the EPS is their net profit divided by 33 cr. (not 30).
If you have enough data (provided in the offer document) calculate the “forward PE” also – that is, use future earnings for the EPS calculation. This is a better indication, because the IPO money will be used to earn more money back!
You must consider the forward P/E alongside the company’s peers – i.e. other companies in the same segment. For instance when TCS went for an IPO, the P/E at the higher price band was 20 or so, cheaper than Infosys at that time which was getting a forward P/E of 23.
What are they doing with the money
Most IPOs get money for the company, and the company may use it for a number of things like:
a) acquisitions (eg. Opto Circuits)
b) setting up new facilities or increasing capacity (eg. Reliance Petroleum)
c) Cancelling high-cost debt (eg. part of GVK, GMR)
This usually involves the company issuing fresh shares for the money received.
Some IPOs involve the existing owners selling. For instance part of the TCS IPO was share sales by Tata Sons and big shareholders. Most of the ONGC, GAIL and IPCL IPOs were selling shares owned by the government. If this is the case, the company gets no money. So give such companies a lower P/E multiple (in TCS’s case, it had to be lower than the PE of it’s competitor, Infosys)
3. What are the risks?
Carefully assess the risks involved and the probability of downside. In Air Deccan’s case, the cost of fuel will severely hit earnings. In GMR’s case, there is a chance of the government spoiling the party, and higher interest rates. Each IPO comes with risks that the business will not continue to do well, and the offer document has to necessarily list these risks. Look at them carefully.
4. Promoter background
Many promoters are involved in court cases for fraud and income tax evasion. The offer document will list these cases. Further if the promoter or any director has ever been involved with a company that has gone bust or is under BIFR, these will be listed. Don’t recklessly invest in an IPO without understanding the background of the promoters; they are after all the ones taking your money!
5. Company litigation
If the company has cases against it, the offer document will list them. Please take good note of these, especially in cases of minority shareholder problems. For instance the upcoming DLF issue is dangerous because DLF was earlier listed and withdrawn from the stock exchanges; since then the company has grown but the minority shareholders have not been given an opportunity to participate in the growth! Such actions are very negative for a new investor – you have very little leeway as a minority shareholder, and you must be satisfied that the company treats them with respect.
Apart from these points, you can look at reviews with various online and paper magazines, and see general opinion on web sites. Largely, the onus of finding out these problems are on you; after all, it is your money. Some investors become cry-babies afterwards saying they didn’t know the company was in bad shape etc. when the risks were clearly laid out in the offer documents. It is imperative that we, as investors, know what we are putting our money into – after all, do we even buy vegetables without checking them out first?