IPO
stands for Initial Public Offer.
It is a
process by which a private company becomes a public company, also known as a
company going public.
IPO’s are
open to purchase by both institutional investors as well as retail investors.
Pros and Cons of IPO’s
Pros
The
company that raises money via IPO can use the money for:
- Repaying debt
- Tapping into a wider and diverse base of investors.
- Raising Capital for further business growth and expansion.
- Allowing older and initial investors to exit by selling their share via IPO’s.
Cons of IPOs
Reasons for
raising money
There are
several reasons for raising money and not all reasons are positive for
investors.
One
possible reason could be to repay debt as opposed to further growth and
expansion.
You need
to figure out whether the company is raising money because it is available or
because it is needed.
This
makes a lot of sense when you consider that most IPOs are launched during a
bull rally rather than a market fall.
An IPO is
not the first time a company raises money, it does so via initial rounds of
private investment before the company goes public.
Now it is
very much possible that these very private investors would want to use the IPO
to exit from their investments, this is a not always the case though but very
likely.
This is
one of the several reasons why IPOS are so highly priced.
Insufficient
Research
A private
company is not as well researched as a public company.
Not many
analysts cover a private company.
A public
company on the hand needs to be periodically audited and have its results
published.
Therefore
due to the lack of coverage, not much is known about a private company before
it becomes public.
This lack
of information works against investors looking to invest in the IPO.
Another
worry is we do not know how the company will perform during tough times since
there is no history of the same.
Timing of an IPO
The
timing of most ipos should make you suspicious.
This is
because most, if not all ipos are launched during a bull rally.
As
mentioned earlier, you need to analyse whether a company is raising money
because it is available or because it is needed.
Investors
assume that when the market is on a high, it will stay the same and when the
market is struggling, it will continue to struggle.
Neither
is true though but companies launching take this opportunity to launch ipos
when the market is on the up since it easier to raise money when the market is
touching new peaks as opposed to launching when pessimism is in the air.
All of
this should make one critically analyse the timing of an ipo.
Valuation
Value of
a stock and price of a stock is not the same thing.
Price is
what you pay, value is what you get.
IPO’s
have historically been exorbitantly priced, more so when they are launched
during a bull phase.
When you
try to understand a stock better, you undertake research on various fronts from
the history, management, finances of the company to the overall sector the
company is a part of.
But what
happens when the company is part of a niche sector, how do you compare the
performance of the company to others?
Listing Gains
The lure
of listing gains is the most common if not the only reason why most invest in
IPO’s.
There is
no guarantee that you will receive any listing gains though since there is no
surety that an IPO will open at a price higher than the allotment price.
If it
does not list at a price than the allotment price then you do not make any
listing gains.
In such a
scenario you either sell at a loss or hold on till you make any profit.
Many
investors that applied for an IPO with the sole purpose of making a listing
profit but do not, end up converting this short term gamble into a ‘long term holding’.
This long
term holding based on no research and compulsion makes for a very grim reading.
NFO meaning
A nfo or a new fund offer is a method by
which a mutual fund scheme raises the initial investment into the fund.
The new fund offer is available for
purchase for a limited number of days only.
After which it becomes unavailable for
fresh purchase or redemption for a couple of days.
Once this time duration is complete, the
nfo no more remains a nfo and is treated like any other open ended mutual fund
scheme.
In which you can invest and redeem as and
when you please, considering it is an open ended fund and you comply with the
necessary exit load calculations.
Should you invest
in a nfo?
You can consider it if:
The new fund offer is a category of fund
that is not existent in your mutual fund portfolio.
If it is going to be a part of your
satellite portfolio.
If it adds a unique touch to your mutual
fund portfolio.
If you understand the functioning,
objectives and risks attached with the new fund offer.
The nfo mutual fund is aligned with your
risk profile.
You should avoid it if:
The new fund offer is not going to add
anything of unique significance to your mutual fund portfolio.
If the nfo is going to be a part of your
core portfolio.
If the only reason you are investing is due
to FOMO (Fear of missing out).
If you do not understand the investment
style and risks attached with the nfo.
The nfo mutual fund is not aligned with
your risk profile.
Summary of why IPOs are not always a good idea:
This is not the 90s
anymore when research was scarce, mutual funds were still at a nascent stage
and the stock market was seen as a gambler’s den.
Things are far more
formalized and regulated although there is always room for improvement.
With IPOs not enough
information is available on the company about to be listed to undertake research
or undertake any form any sort of opinion, although past returns and
performances are no surety for the future but they do help understand how a
company does overall specially when things are not looking so good.
IPOs these days are
outrageously valued even though there are not enough credible numbers to back
them.
Be it mutual funds or
direct equity, a strong sense of conviction is needed since you invest for the
long term ideally but the same is not visible with IPOs since neither credible
numbers are present nor enough resources on the management is available.
Investments should be
simple and anything beyond that should provide you with strong enough reasons
in terms of quality as well as quantity and past results and future prospects
to gain your attention.
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