How to do IPO Analysis for Listing gain

8/26/20237 min read

Contents

What is an IPO?
Key terms related to IPO ( OFS/ Fresh Issue/ QIB/ NII / Anchor investors)
Promoter holding / VC/ PE investors involved
Purpose of IPO
Strength of core business and industry trends
Sales and profit growth trends
Valuation
Subscription status of QIB / NII/ Anchor investors
Grey Market Premium (GMP)
Analyst recommendations
Whether to hold a company post IPO

1.What is an IPO?

In stock market, we have primary market and secondary markets. Primary market is referred to the listing of firms for the first time in stock exchange (NSE/BSE). This primary market is also called Initial Public Offering or IPO, where firms offer common shares to public, with the objective to raise capital from the public.

Before listing on exchanges, there are stringent scrutiny requirements of SEBI which have to be passed. Company needs to submit a DRHP ( Draft Red Herring Prospectus) for that, usually prepared by merchant bankers appointed by the company, who also play a role in allotment process based on subscription, marketing the IPO by IPO roadshows etc.

2. Key terms related to IPO ( OFS/ Fresh Issue/ QIB/ NII / Anchor investors)

Fresh Issue/OFS/ Total offer size

In every IPO offer amount, 3 terms are mentioned- Total offer size, Fresh issue, OFS

If fresh shares are issued by the company diluting promoter equity, then that portion is called fresh issue.
If existing shareholders( who have entered the company earlier as angel investors/ PE /VC investors at private limited stage, before going public) are exiting the stock during the IPO, then their portion which is offered to fresh investors for sale is known as Offer for Sale (OFS). Promoters may also offload some stake via OFS.

Together, Fresh issue and OFS constitutes Total Offer size.

QIB/ NII/ Anchor investors

There are certain % quota mentioned for each IPO for QIB, NII, Retail.

QIB is Qualified Institutional Buyers, or investors who are professional and well informed ones, which constitute DIIs ( Domestic institutional investors like mutual fund houses, Banks ) and FII ( Foreign Institutional Investors). Maximum 50% can be offered to QIB.
Part of the offer under QIB is offered to anchor investors (QIB who invest before opening of IPO with minimum of 10 crore capital) one day prior to opening to public. Price offered to anchor investors can be lower than issue price, and maximum of 60% of QIB can be raised through anchor investors.

Retail quota of an IPO is for retail investors, investors who are investing less than Rs 2 lakh.

NII quota is for Non Institutional Buyers, are individual buyers , usually HNIs ( High Net Worth individuals). For NII category, one has to apply for shares worth of Rs 2 lakh minimum.

3.Promoter holding / VC/ PE investors involved

Promoter holding is a critical factor to look at. We need to look at promoter holding post IPO. It gives us an idea that post IPO, whether the company will be majority owned by single promoter entity or part promoter, part VC/PE funds. If there is a large stake of a VC/ PE fund, there may be continuous selling pressure in the stock if they keep offloading stake when price appreciates by some amount after IPO.
We need to look at post IPO holdings of VC ( Venture capitalist) , PE( Private Equity) investors , angel investors - who entered the stock earlier.

We need to look at the participants of OFS, which VC/ PE / angel investors are offloading the stock, if they are, then when did they buy stake. Usually VC/PE funds have a life where they have to sell off their investment after 5-10 years. But if a VC/PE investor who has bought it 2 years back and exiting via OFS, that is usually not a good sign for listing gain as well as future prospects of the company. ( unless valuation has jumped a lot in these 2 years and they are exiting at handsome profits). It also matters, what stake they are offloading in OFS, part stake of full exit.

In short, the overall dynamics of ownership of strong hands - Promoter/ VC/ PE/ Angel investor is important to understand for getting an idea of the future movement of the stock price and has an impact on listing gains.

4. Purpose of IPO

Understanding the purpose why a company is bringing IPO is very important for understanding probable listing gain it will give

Purpose can be

To fund capex growth
Debt reduction
Working capital needs
To give exit to existing VC/ PE investors

Capex
If the company is growing at high pace and needs funds which it will utilize in capex for further growth to cater the impending demand in the industry, then it is to be considered good for listing gain.

Debt reduction
Debt reduction will unlock more profits for the company, and can take further debt in future for capex needs - this is also positive for the company, but has to be evaluated whether only debt reduction is the purpose, and whether company is generating enough cashflows, working capital cycle of the company - these to be found out in order to ensure company will be able to self sustain this debt free status.

Working capital needs
If working capital needs is the purpose, understand the current working capital required by the company and the growth rate of revenues, whether further funds are really required for working capital and funds raised will suffice the working capital needs for how long.

To give exit to existing VC/ PE investors
Giving exit to existing PE/VC investors is one of the reasons company brings IPO. But if giving exit to PE/ VC investors is the sole purpose of the IPO and there are no actual needs for the above 3 purposes ( capex, debt reduction, working capital), then beware of such IPOs, those may not give good listing gains.
So identifying this becomes critical part of IPO analysis.

Overall, if the purpose of IPO is for fuelling future growth of the company, then it is considered a good sign.

5.Strength of core business and industry trends

Identifying the core business and key areas of strength/ core competitive advantages or moats of the company becomes very important for the future success of the company and how investors will give premium to the company.
Industry trends also matter, for example if the industry in which the company operates is a fast growing one and currently trending, then it is likely that the market will pay more premium to that company, hence more listing gain.

To read more on what to look for in a good company read

10 important factors and ratios to consider while stock filtering

6.Sales and profit growth trends

Sales and profit growth trends to be considered as an important criteria for stock selection, pre and post IPO.
If for IPO bringing company, sales growing greater than 15% CAGR and profit growing at 25% CAGR or more, that company is usually considered as high growth company, and those companies have chances of more listing gain.

7.Valuation

Valuation of a company in terms of P/E ratio ( for profit making companies , except banks- for banks we look at P/B ratio) at listing price, compared to its peers to be looked at. It is expected that a new company won't get similar valuation from market like a well established peer, but if the prospects of the company is very good, it may get valuation nearing the established peer.
Important is to identify whether it is valued similar to or higher than well established peers, in that case chances of good listing gains becomes less.

Sometimes, a high growth company is quoted at a similar valuation to listed peers and gets that valuation from market also.
Companies listing with gross undervaluation with respect to peers but coming off as very good in all other parameters mentioned here are recipe for excellent listing gains.

8.Subscription status of QIB / NII/ Anchor investors

An IPO remain open for subscription usually for 3 days. Checking the subscription status- whether it is oversubscribed or undersubscribed before applying can give an idea also about listing gain prospects.

As we talked earlier, IPO subscription opens for anchor investors 1 day before it opens to public. So having a look who are the anchor investors involved and percentage of QIB already subscribed by anchor investors give the first indication of the demand for that IPO. Anchor investors usually have a lock-in period ( during which they cannot sell the share) of 1 -2 months.

An IPO is 6 times oversubscribed- means number of shares applied for is 6 times the number of shares on offer.
More than overall subscription status, for listing gain indication, it is important to check how many times QIB portion and NII portion is oversubscribed, as they are more well informed and well researched investors than retail investors.

9.Grey Market Premium (GMP)

Unlisted shares trade in grey market ( unregulated exchange), some high-risk taker investors participate in that. The premium that grey market is giving to the stock above the listing price is called grey market premium or GMP. Checking the GMP before applying also indicates the possible listing gain that an IPO may give.
Many people base their IPO application decision solely on GMP, which is not advisable. But considering GMP along with all other factors mentioned will help predict listing gain much better.

10. Analyst recommendations

Finally, consider how many analysts are recommending to subscribe just for confirmation purposes of your analysis. Never base your decision or judgement entirely on analyst recommendations for listing gain. That is a recipe for disaster.

In stock market, we must use our own analysis to succeed, not news or other's recommendations. ( read more)

11.Whether to hold a company post IPO

This depends on the evaluation based on above parameters, mostly the future prospects of the company . But in most cases, it is good to exit with listing gain, since most stock prices fall after listing due to profit booking.

If you are an expert at picking companies with respect to future prospects and doing this successfully in midcaps/ smallcap existing companies, then you may apply the same for IPO companies too. In most cases, you will get a chance to re-enter at a lower price later.

However, if you are mostly a largecap investor, or relatively new, it is best to sell off the stock on listing day with listing gains received. Even if there is listing loss, better to exit same day, else you may have to hold the stock for years which you may not like to.

If interested, may visit this page for all IPO analysis

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How to do IPO Analysis for Listing gain

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