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Why Do Traders Think IPO is a Good Idea?

What are IPOs?

Companies need money to operate. This can be sourced from bank loans and other borrowings or by raising capital through share issues. Each share represents a portion of the company. So, the company effectively sells a portion of its holding to raise money. So, you - the investor - then hold a right over the company and its profits. This issuance of shares happens in a separate section of the stock market called primary market. Once the shares are issued to investors, they get listed on the secondary market, where they are traded on a daily basis. A company many issue thousands of shares at one time. For each such share, investors pay a certain amount. The total amount a company gets for its shares is the 'capital' raised. This money is then used for operating the business. This process is called as listing or 'going public'.

How to Invest in IPOs?

There are two types of IPOs depending on the price of the shares - fixed price and book building issue. In the former, as its name suggests, the company fixes the price of shares in advance. No investor can get the shares for a rate higher or lower than this amount. In the book building issue, however, you have to bid for shares. The company will give you a range of prices. You have to bid within this range. Depending on the bids, the company will then allot shares to investors. This process - called Book Building - takes 15 days. To do so, you have to place money in your IPO trading account and then order. You have to do this before the IPO closing date. If your bids are successful, you will receive a Confirmatory Allotment Note (CAN) on the settlement date. If you fail to get any shares in the issue, your money will be refunded within 15 days.

Advantages of Investing in an IPO

The stock market is all about betting on the future growth potential of the company. The sooner you buy shares of good company, the better. This will help you take advantage of a higher rise in share price. An IPO allows you to be one of the first investors to unlock the company's potential. This means, you effectively get to buy shares at cheaper rates. For example, Infosys shares got listed at Rs.95 in June 1993 (but adjusted for bonus and splits, the original IPO cost of these shares works out to 48 paise). Today, these very shares are worth over Rs.2,000 apiece. So, if you had invested in the Infosys IPO, your shares' value would have jumped over 4000x (a staggering 458233% increase). Secondly, 35% of the share offering is reserved for retail investors. As part of this reservation, retail investors can bid for shares worth up to Rs.2 lakh. This means, you have a good chance of getting shares allotted in every IPO, even the unsubscribed ones.

The government divested 10% of its stake in Coal India in 2010 through an IPO. This offer was so successful that it got subscribed 15.28 times. This helped the government collect a whopping Rs 2.4 lakh crore from the share sale. On the first day after listing, Coal India share prices jumped 40% from the IPO price. This makes it one of the biggest IPOs in India.

As a word of caution one must due diligence and research before investing in an IPO. You can get details about latest IPO in India here.

Risks associated with an IPO

POs are usually issued by new companies, which are not yet established or growing at a steady path. The risk involved is thus higher. You are essentially betting on the company's growth prospects. If the company fails to take off as promised after the IPO issue, its shares may tank and you may lose your money. Secondly, unlisted companies do not have to publish financial performance every quarter. This means, it will be more difficult to track the company's past performance before listing. However, a company that applies for listing has to provide records of its past financial performance. These will be part of the company's prospectus.

Things to remember for an IPO

Always ensure you read the company's prospectus clearly. This will mention all details of the IPO - the company, its finances, the amount of money it expects to raise, the type of shares that will be issued, the number of shares on offer and so on. This is the only way to know about the company's financial performance. Never invest blindly in an IPO.

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