There’s always a buzz when a company goes public for the first time. At times this buzz turns into excitement if the company going public is a well-known brand. An IPO allows investors to own shares of a company before it begins trading publicly, often with the promise of future growth.
IPOs in India have been able to garner significant interest from investors in the past decade mainly due to some impressive success stories. However, all IPOs are not similar, and it is difficult to predict the performance of an IPO post-listing.
In this article, we will try to explore some key indicators like the company fundamentals, industry trends, and investor demand which can provide us with insights into an IPOs potential success.
What determines IPO Success?
There are multiple factors, some are intrinsic to the company, and others external. By evaluating these factors an investor can make an informed decision whether a particular IPO is worth investing in. Here are the factors to consider.
- Company Fundamentals
- Industry Trends and Growth Potential
- Market Sentiment and Investor Demand
- Strength of the Management Team
- Valuation and Pricing of the IPO
Company Fundamentals
The company’s fundamentals provide a deep insight into the financial health and potential profitability of a business. This should be the foundation of any investment decision, especially in the case of an IPO, where the company enters the public market for the first time. Here are a few factors within company fundamentals that an investor should examine to help forecast the performance of an IPO.
Revenue and Profit Trends: Consistent revenue and profit growth are good signs of strong demand for the company’s products or services. Investors must review historical performance, if available, to understand the growth trajectory.
Debt Levels: Debt is the money the company has borrowed to fund its operations, growth, or other financial needs. A high debt level could adversely impact a company’s performance, especially in times of economic slowdown or if the interest rate increases. Low or manageable debt levels indicate financial stability.
Margins: Gross and net profit margins indicate how well the company can manage its expenses in relation to its revenue. A higher margin indicates the company can retain a healthy portion of profit from its revenue. A higher margin indicates that the company has a competitive edge.
An analysis of a company’s fundamentals gives a very clear idea about the financial strength and growth potential of the company. Companies with very strong fundamentals are those that tend to do better in the long run; hence they can be excellent IPO prospects.
Industry Trends and Growth Potential
The industry in which the company comes with an IPO operates is one of the critical determinants of the success of an IPO. For example, companies operating in high-growth industries like technology,, e-commerce, and renewable energy have drawn enormous investor attention because of the high potential for innovation and ever-growing market demand. On the other hand, companies that are operating in declining industries may find it difficult to maintain investor enthusiasm. Here’s how industry trends can impact an IPO.
Sector Growth Rate
Sectors that are expected to generate higher growth rates are considered relatively safer bets in terms of IPO investment. These sectors include fintech, e-commerce, and healthcare, where demand is very high due to alignment with overall economic and technological shifts.
Regulatory Environment
The regulatory environment can either help or hamper a company’s growth. For example, the Indian government’s push for renewable energy has benefitted companies operating in the green energy sector. On the other hand, stricter regulation on data privacy can impact companies from the tech sector.
Competitive Landscape
In a competitive market, companies need a unique selling proposition (USP) or a competitive edge—something that makes them stand out from others in the same sector to succeed.
For example, a company with a proprietary technology, a strong brand, or a large customer base might have an advantage over its competition. When a company has a clear USP, it is usually better positioned to attract investors, grow its market share, and perform well after its IPO.
Market sentiment and investor demand
Investor demand is important for an IPO’s success; it decides the level of interest the market has in shares of a company. Investor sentiment can be influenced by market conditions, economic factors, and even international events. This is how you can measure demand as well as sentiment.
Subscription Numbers
The subscription numbers of Qualified Institutional Investors (QII), High-Net Individuals (HNIs) & Retail Investors could be a good indicator of demand. An IPO that is highly oversubscribed will indicate robust demand, thereby making the listing day performance very good.
Grey Market Premium (GMP)
Although not an official metric but gray market premium of the IPO could well hint at the demand for the IPO in the market. A high GMP generally means that the listing day price of the share will be higher.
Type of Investor
The retail investor normally drives the initial level of interest for an IPO, while institutional investor interest shows confidence in a company’s fundamentals as well as long-term growth.
Strength of the Management Team
A capable and experienced management team is very likely to help an IPO become successful. Investors want leaders who not only understand their business well but will also be able to maneuver the complexities of a listed company. From an investor perspective, a few areas for focus are:
Leadership experience
The Management’s track record in the industry is worth analyzing. It is equally important to know the past record (successes and failures) of the management team. A strong leadership team with a proven track record translates into better decision making which benefits the shareholders in the long run.
Corporate Governance
Good corporate governance is characterized by transparency, accountability, and compliance. Companies that have a history of ethical practices and sound corporate governance are likely to perform well once they go public because they will most probably make decisions in the best interest of the shareholders.
Board of Directors
A diverse and experienced board can provide valuable insights and guidance to the company. Investors view a strong board as a positive indicator of the company’s stability and growth.
IPO Valuation and Pricing
Valuation represents an important component in knowing whether an IPO is priced attractively. A good valuation could possibly indicate that the company possesses strong growth potential. However, a high valuation can also make the corporation overvalue its worth, resulting in a lower listing price. Here is an approach to understanding the IPO valuations.
Price-to-Earnings (P/E) Ratio
P/E is the most commonly used valuation metric. Comparing the P/E ratio to industry peers gives some insight into whether or not the IPO is fairly priced. The P/E ratio indicates how much the investors are willing to pay for each rupee of the company’s earnings. For example, if the P/E ratio is 10, it means investors are willing to pay 10 times the company’s earnings for each share.
If a company’s P/E is higher than its competitors, it means the company might be overvalued. On the other hand, a lower P/E might indicate that the stock is undervalued, depending on the company’s growth prospects.
Price-to-Sales (P/S) Ratio
If the company is not yet profitable, then the P/S ratio can be used in place of P/E. A Low P/S ratio as compared to the industry average may indicate that the IPO is relatively undervalued and has considerable scope for growth. A low P/S means investors are paying less for each rupee of sales, indicating that there is room for growth if the company’s revenue continues to increase.
Evaluating the IPOs in the Indian Scenario
The Indian IPO market has its own dynamics, which are influenced by a number of factors, be the regulatory policies, economic growth, or the enthusiasm of retail investors. In the last few years, fintech, healthcare, and renewable energy sectors have had significant traction from both retail and institutional investors.
Strong fundamentals and heavy demand from investors are major reasons behind the impressive performance of some Indian IPOs, such as Zomato and Nykaa. While a few others have failed miserably due to unacceptably high valuations or lack of interest from investors.
Conclusion
One can never predict the exact outcome of an IPO, whether it will succeed or fail. However, much can be gathered by analyzing company fundamentals, industry trends, investor demand, the strength of management, and valuation. When looked at together, it will help the investors make an informed decision.
It is always useful to go through the company’s Draft Red Herring Prospectus (DRHP) before investing in an IPO.
Happy IPO Investing!
Related Information & Articles
Current & Upcoming IPOs in India
Types of IPOs: Fresh issue Vs Offer for Sale
How to Easily Apply for IPO via UPI in India?
IPO Allotment Status: Process & How to Check
