Get answers for the following questions to determine whether or not you should invest in a particular IPO ?
1. Is this an IPO or an FPO?
- In IPOs, initial public offers, company decides the price and the collective secondary market discovers the true price post-listing after more information inflows/analysis.
- In FPOs, follow on public offers, the price is already discovered; gains/losses can only be marginal; no new information for the market to analyze/process.
2.Is this a fixed-price or a book-building issue?
- The methodology, classes of investors and issue pricing are totally different.
- There is no book or price discovery in a fixed-price issue.
- There are no reservations for FIIs/HNIs in a fixed-price issue; 50% of the issue is reserved for small investors (in book building, it is 35%).
- Fixed-price issues are typically small.
| Issues in 2004-05 (Rs in crore) Source: Prime Database | |||
| Issue | No. of | Issue | Average size |
| Fixed Price | 10 | 378.82 | 37.88 |
| Book Building | 19 | 21,052.74 | 1,108.04 |
3. Is this a “good” promoter?
- Get to “know” the promoter – that’s the key.
- If the promoter is okay, almost all other factors will automatically get taken care of.
- If there is any foreign collaboration of repute, it helps.
4. What is the promoters’ background and experience?
- Experience in the same business/industry (promoting individuals/ promoting companies)
- Are there any material defaults/ litigations against the company or its promoters?
- Persons/Companies that have not been compliant with laws of the land reflect a worrisome mindset.
- If you find too many defaults/litigations of a material nature or even one of a very serious nature, a the issue.
– Criminal proceedings against the promoters.
6. What is the status of the issuing company?
- Holding company
- Main company
7. How has been the performance of the company?
- Number of years in the business
- Size of the company
- Growth rate
- Market share and growth
8. Are the financials, specially the recent ones, reliable?
- Many resort to window dressing; high sales often lie in sundry debtors, profits could be because of a very high “other income” or “unusual income”.
- Beware of bloated previous year’s financials; amazing how almost every company performs so exceedingly well in the year and quarter preceding the issue!
- Look at aging of sundry debtors (and earlier write-offs).
- Look for changes in accounting policies (depreciation etc.), in financial year.
- Look if there are any significant Notes to the Accounts.
- Look if there are any significant qualifications by the auditors.
9. What to look for in the Balance Sheet?
- Fixed assets
- Investments
- Loan and advances
10. What are the key financial parameters/ ratios to look at?
Earnings per share (EPS)
- EPS measures the earnings a company makes for each share in existence. It is calculated by taking a company’s net earnings and dividing them by the number of shares in issue.
- A higher EPS is regarded as better than a low EPS as it means investors are earning bigger profits for every share they own.
- Investors look not only at the current EPS but also at estimates of future EPS to get an idea of the profits they will earn in future years.
Price Earnings ratio (P/E)
- The ratio you will see mentioned more than any other is the Price Earnings Ratio, which you will often see represented as P/E.
- The P/E measures whether a company is cheap or expensive. It is calculated by dividing a company’s share price by its earnings per share (profits after tax divided by the number of shares in issue). As a rule, the higher the P/E, the faster its earnings are growing but if the P/E is high compared with other companies in the same sector, it could also mean the shares are overvalued.
- This ratio enables any business to be compared with another, although in reality investors tend to compare companies against those in the same industry sector or against the P/E on the entire market.
- Investors look not only at P/Es based on the past year’s earnings but also at estimates of future P/Es, also known as prospective P/Es. This gives investors an idea as to how fast a company’s earnings are expected to grow in the future and, therefore, whether their shares are worth buying or not.
PEG ratio
- If you are investing in growth companies it is worth looking at a company’s PEG ratio. This ratio, which shows a company’s P/E relative to its earnings growth rate, is worked out by taking the prospective P/E ratio and dividing this number by the prospective EPS growth.
- The lower the PEG ratio, the better value a company’s shares are.
Return on capital
- This ratio helps investors assess how hard a company is making its assets work. It is calculated by taking profits before interest and tax are removed and dividing this figure by the capital employed.
- Broadly speaking, the higher the return on capital, the more successful a company is.
EBITDA and EV
- EBITDA is a profit key ratio that looks at the Earnings Before Interest, Tax, Depreciation and Amortisation. It is used to assess the operative profitability of a company.
- You can use this ratio to analyse companies that reinvest heavily in their businesses by taking the Enterprise Value and dividing it by EBITDA.
11. How are the cash flows?
- Is it negative?
12. What is the dividend track record?
- No relevance in the case of IPOs
13. What is the promoter’s attitude towards shareholder rewards, in case of listed group companies?
- Dividend policy
- Bonus issues
- Rights issues
- De-listing of group companies
- Past public issue pricing
14. How has been the performance of the group companies?
- Number of years in the business
- Size of the companies
- Growth rates
- Market shares and growth
- Financials
15. How significant are the related party transactions?
- Is it a family business?
- Do group companies constitute the main clientele?
- Is most raw materials sourced from group companies?
- Extent of related party financial transactions?
- Is there any conflict of interest among group companies?
- Are there companies in the group doing the same business?
16. Who is on the Board of Directors?
- Family-controlled or broad-based
- Independent directors
- Key directors-in terms of experience and “connections”
- Compliance of Clause 49 of the Listing Agreement on Corporate Governance
16. What are the products/ services of the company?
- Old economy/ new economy?
- Cyclical?
- “Flavour of the season”?
- Upstream/ downstream?
- Market outlook?
- Be concerned about your own exposure to a particular industry.
17. What about technology?
- Do not bother too much about this.
18. What about customers?
- Over dependence on one or a few customers?
- Too many fixed priced, long-term contracts etc?
19. What is the size of the issue?
- A large issue ensures better allotment as also better liquidity.
20. What will be the public float after the issue?
- This is critical as public float finally determines the liquidity.
21. What is the promoter’s holding after the issue?
- A small post-issue stake does not inspire much confidence
22. Is the price justified?
- Do not be guided by ‘par’ ‘premium’ parameters
- In “Justification of Issue Price”, look whether P/E has been calculated on recent period EPS or on weighted average of 2-3 years.
- Look at the peer group prices, but do not rely entirely on it.
- Industry low/ average/ high figures of P/E are deceptive; there are no two similar companies, each is unique.
23. What has been the capital build up?
- Previous public issues/rights issues/overseas issues/preferential issues.
- To whom, when, at what price?
- Is there any venture capital/private equity fund investment in the company?
- Who invested, when, at what price, for what stake?
- How does the offer price compare with price of allotments made to them?
- Are these now funds exiting fully or partially in this offer?
- Partial exit or no exit is more confidence building; VCs are expecting a higher secondary market exit price. In 2004-05, there were two such companies where VCs exited partially, NDTV and UTV.
24. What are the objects of the issue?
- Finance a new project (new/diversification)?
- Undertake expansion
- Augment working capital?
- Repay debt? (to promoters?)
- Do acquisitions?
- Fund subsidiaries?
- Open branches?
- For general corporate purposes?
- Exit to promoters/others (offer for sale); No fund inflows into the company?
25. What are the components of the project cost?
- Any oddities in the components of the project cost?
- Comparison of cost of projects of two “similar” companies difficult as there would rarely be two exactly similar projects.
26. What has been the utilisation of existing capacity?
- Is the present capacity fully/ substantially being used?