Do some homework before investing in stocks - Indian IPO Blog

Friday, January 13, 2012

Do some homework before investing in stocks

In these times of gloom, it becomes all the more important to do some research before you go around chasing that new IPO in the town. While we can’t ignore the robust returns that Coal Indias and Jubilant Foodworks of the world have generated, one has to look at the other side of the story as well. Many of following things apply to secondary market as well, though they are specially relevant in case of IPOs

Get the basics right! Look at Fundamentals!

Overlooking fundamentals of the company is quite common in a haste to make a quick buck from the market. Many gullible investors get so lured by high Grey Market Premiums that they hardly bother to get an idea even about what the company is and what it is doing, let alone the balance sheet position or profitability! Investors should make it a point to read the IPO Grading Document from credit rating agencies on fundamentals of the company. Credit Rating Agencies in India assign IPO Grades on a scale of IPO Grade 1 to IPO Grade 5 with IPO Grade 1 indicating relatively poor fundamentals and IPO Grade 5 indicating that the company has strong fundamentals compared to other listed entities

Avoid the ‘Halo’ effect

Just because your buddy, broker, butler or barber says that the company is going to be the next Infy, it isn’t going to make it so. Remember that it is the job of investment bankers and managers of the issue to secure maximum subscription and so they may create a lot of hype around it. Avoid the herd instinct and take some time out to refer to the Red Herring Prospectus – this is the single most important document offering a wide range of details and disclosures about the company and its business. Have a look at the promoters’ standing by going through their background, the experience in the industry, the performance of the other companies promoted by them. Check to see whether there are major litigations or other risk factors against the promoters or the company. A quick look at these things would make sure that you do not invest purely on hunches, rumours, or 'hot' tips

Evaluate company performance

At the end of the day, share prices are a reflection of how good the company is performing and how good it is expected to. Grabbing a copy of the financial statements of the company for previous few years and going through them patiently will certainly do justice to your time spent on it. Look at the balance sheet position and profitability ratios of the company and compare them with similar companies within the industry. Bear in mind that if a business does well, the stock would eventually follow. Watch out for window dressing of financial statements Check if the figures in line, above or below par with the similar companies in the industry. It is amazing how some loss making companies suddenly turn profitable exactly a quarter or two before the IPO! See to it whether there is a sudden improvement in the numbers just before the issue without any justifiable reasons.

Check out the Price to Earnings (P/E) Ratio considering the price band and compare the same with peers of the company. P/E Ratio is an indicator of the number of multiples that the market price would be over its current profit levels. The general rule of the thumb for P/E is that the lower the P/E, the better it is for the investor, because a lower P/E multiple essentially means that you are getting to buy something at a price which can be considered cheaper keeping the earnings of the company in perspective. Bear in mind, though, that during booming times it is easy to get carried away on this front since the prices of P/E of peers are also at elevated levels.

Glance over the objects and future prospects

Check whether the objects of the issue seem to be line with the business of the company and congruent with its future prospects. See to it whether there are companies within the group doing the same business and whether company intends to utilize the proceeds in a way that would be in the interest of itself or would rather benefit other companies in the group. Also, have a look what would be the promoters’ holding after the issue. A smaller post-issue stake may indicate the reduced promoters’ confidence in the future prospects of the company

Cheap, yet so expensive!

Legendary Investor Warren Buffett once said “It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price!” Now, whether the quote goes down well with you or not depends on how you look at some of those low priced stocks. Many Investors often get lured by the low tick size of IPOs as they think that would buy them more number of shares. They tend to buy cheap stocks, which are not that valuable, only to repent the decision later. At the same time, you need to watch out for extraordinarily high-priced IPOs as well. Keep in mind that however good a company’s future prospects are, a high price set at the IPO stage itself would eat into the prospect of an appreciation later. Comparing the company’s EPS with the average P/E Ratio for peer companies can give a good idea on what is a fair price for the IPO. If the price band seems far stretched from the fair price, you may be better off buying from secondary market instead

All in all, the time and effort you spent in taking some of these basic precautions before hopping in is likely to keep your money a lot safer! Do not invest if you think that price is not right or you aren’t convinced about the company’s business and whatever you do, do not invest simply because your buddy, broker, butler or barber does so!

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