WHAT TO LOOK FOR IN A RED HERRING PROSPECTUS IN AN IPO?
Investing in an IPO? How much of the information you collect is first-hand? Have you checked the Red Herring Prospectus of the company you intend to invest in?
WHAT IS A RED HERRING PROSPECTUS?
A red herring prospectus is an offer document filed with SEBI for registration, before an IPO.
The name ‘red herring’ comes from the disclaimer IN BOLD RED on the cover page that facts and figures are not final, and may change before the IPO is launched.
However, it does have a lot of information investors should look for, before making an investment.
WHERE DO YOU FIND A RED HERRING PROSPECTUS?
It is on the SEBI website under Offer Documents section, or websites of stock exchanges.
The final document incorporates changes based on suggestions made by SEBI.
WHAT SHOULD YOU LOOK FOR BEFORE INVESTING IN AN IPO?
1. Understand the business
You need to know what exactly are they doing. What are the sources of revenue? Does revenue come from the end-user or the seller?
For example, Zomato earns more from the commission it charges the restaurants, than the delivery fee it gets from the end-user.
Details on business strategy and operations are available in the prospectus.
2. Understand the competition
Which are the other companies operating in the space, and how are they poised to grow? What segment of the population is being targeted for selling?
Anything that targets millennials looks set to grow. But this segment also tends to switch loyalties to another brand or product quickly.
3. Understand the present sources of funding
Who has invested in the company? What is their track record?
If the company is making losses, are they looking for an exit route by distributing losses to retail investors?
4. Understand the management
Scroll down to the section which gives an introduction about the company.
Who are the people behind the venture? What is the kind of experience they bring to the table?
Have they been embroiled in legal or compliance issues in their previous assignments?
Is the company facing legal issues right now? Have they been penalised by regulatory bodies for non-compliance?
What kind of talent are they attracting from the market in management roles?
5. Understand financials
Check the financial tables. A red herring prospectus does not have final details of size of IPO or offer price. It is prepared before finalisation of the details.
Check if the company is making profits or operating profits.
What kind of expenditure is being incurred on promotion? Have they cut losses in the last 1-2 quarters before an IPO by cutting down promotional expenses? Is there a sudden spurt in revenue which looks suspicious?
An independent auditor’s report will give details of assets and liabilities, debt, share capital, cash flow, financial assets, present equity structure and changes if any.
6. How has the offer price been decided?
What is the basis of calculations?
- Earnings Per Share (EPS)
- Price-Equity Ratio (PE ratio)
- Return on Net Worth (RoNW)
- Net Asset Value per Equity Share
How does the company stand on above parameters in comparison with companies in the same space?
A fixed price issue is based on above parameters.
A book-built issue involves pricing based on investor response in the past to other issues.
HOW IS GOVERNMENTAL POLICY DISPOSED TOWARDS THE INDUSTRY?
Do you expect future government policy to work for or against the business? Like startups which involve the use of cryptocurrency in a big way may face a setback in future.
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How should a new investor, not initiated into stocks, terminology, etc., go about choosing an IPO to begin investing?
Consult a financial advisor. Do not block large chunks of money in IPOs.