Investing in an initial public offering has become significantly riskier in 2023, as stock markets experience increased volatility amid a worsening global economic slowdown. Here are five key rules to help retail investors select the best IPOs.
Investments in initial public offerings (IPOs) fell sharply in 2022, as stock markets around the world experienced a period of consolidation following record gains the previous year.
An ongoing global economic slowdown, geopolitical tensions, and fears of an impending recession harmed many high-profile public listings last year, discouraging investors from investing in IPOs. While India’s IPO market has outperformed the rest of the world in recent years, most of the companies that went public had low valuations.
Most retail investors invest in an IPO without conducting extensive research. The most basic rule that IPO investors should follow is to conduct research on the company, which is especially important during a period of economic uncertainty.
Before investing in an IPO, conduct thorough research on the company’s background, business model, unique proposition, funding, cash flow, and profitability. Any retail investor seeking such information on an IPO-bound company can consult the draught red herring prospectus (DRHP) and the red herring prospectus (RHP) (RHP).
While most of the information can be found in these documents, investors should also conduct extensive online research to learn about its business milestones, competitors, and other important facts.
The success of a company is heavily reliant on the decisions made by its top management, so it is critical for investors to conduct thorough background checks on the top management as well as the company’s promoters. Companies with strong leadership typically outperform on the stock market, either immediately after listing or over time, due to their ability to generate revenue and profitability.
Retail investors should ideally seek out IPO-bound companies with strong brokers, as large brokerage firms are more likely to be associated with financially strong companies with a sustainable business model. While strong underwriters are not a guarantee of a successful IPO, experts believe they are an important IPO investment strategy. As a result, investors must exercise extreme caution when selecting an IPO involving small brokers.
Although smaller brokers have some advantages, such as more opportunities to purchase pre-IPO shares due to a smaller client base, it is always better to conduct a round of research before investing.
Many retail investors sell their holdings right after a company goes public, rather than waiting for the lock-in period to expire. A lock-in period is typically a legal contract that specifies how long early investors/insiders must keep their shares before they can sell them. A lock-in period typically lasts a year, but it can range from three months to two years.
Waiting for the lock-in period to end is a good strategy for retail investors, according to experts, because it provides valuable insights into the company’s future potential, depending on whether early investors or insiders sell or hold their shares after the lock-in period ends.
While these are some useful points for IPO investments in 2023, retail investors should also seek advice from financial experts before making a final decision.
