How to Pick the Right IPO in 2024?

Indian IPOs have been raising the heat lately. This fiscal year, investors have gained an average of over 34% in every IPO. Between April and September 2024, 40 companies raised ₹51,365 crore through IPOs, a 95% increase from the same period in 2023–2024. In fact, some IPOs have given attractive listing gains like Bajaj Housing Finance (136%), Unicommerce Esolutions (94%), Premier Energies (87%), and so on! 

Read till the end for tips to keep in mind while choosing your next IPO investment.

Your primary objective when deciding to invest in an IPO is to find out what the fair value of the stock is compared to the market value. 

For example, let’s say you conclude that a glass of chai is worth ₹20 (Fair value) because of the cost of the ingredients and the chai stall and the effort and experience of the chaiwala. If the chaiwala sets a price of ₹15 (Market Value), that’s a 25% discount from the fair value, and would be a good decision to buy. 

To understand if a company is fairly valued, you need to look at 3 drivers of value

1. Company (like what ingredients go into the chai, how good the chaiwala is at making the chai, etc)

2. Industry (Are the number of chai drinkers and chaiwalas increasing? How much are other chaiwalas charging for their chai, etc)

3. Investor interest (How much are other people willing to pay for the chai?)

Here are the steps you can follow to differentiate a good IPO from a not-so-great one

Step 1: Understand the business 

This is the more subjective aspect of understanding the company. It includes understanding - 

1. What the company does

2. What are the different streams of revenue for them 

3. Whether the business model is sustainable for the long term and the company is in a growing industry 

If the company you’re analysing is adding value to a growing industry and seeing an increase in demand, that’s a great start! 

Step 2: Understand the company’s financial health

You can find these details online; simply look into the company’s historical financials and Red Herring Prospectus (RHP) for the numbers.
Metrics to consider: 

• Revenue growth: Is it steady or fluctuating?

• EBITDA: To check for profitability 

• Net income: To check whether the company is generating profits or seeing losses

• Debt-to-equity ratio: Measures the company’s leverage & ability to meet long-term debt obligations

• Free Cash Flow: Indicates liquidity and how well the company is generating cash from its operations

Step 3: Understand the company’s valuation 

The company’s valuation gives you an idea about how it is doing as compared to peers and within the industry. 

Metrics to consider:

• Price-to-earnings (P/E) ratio: Shows how the market is pricing the company relative to its earnings. A higher P/E could signal high expectations, but it might also indicate overvaluation

• Price-to-sales (P/S) ratio: This is usually used for valuing a company that isn’t profitable yet, but is showing signs of growth

• Price-to-book (P/B) ratio: Evaluates the company's market value compared to its book value (assets minus liabilities)

• Enterprise value to EBITDA (EV/EBITDA): Measures the company’s value compared to its earnings

Step 4: Check if the company is growing & predicted growth potential 

This helps you evaluate the company’s future prospects and expansion plans.

Metrics to consider:

• Revenue growth rate: Check the company’s historical growth rate with the industry average to understand future potential.

• Addressable market size (TAM, SAM, SOM): These metrics give you an understanding of how the company can grow in terms of its user base

• R&D spends: This helps you understand how the company is staying up to date with the latest in tech and innovation. It’s a key indicator of future growth. 

Step 5: Evaluate the board & shareholder structure

Understanding the people who run the company gives you an idea about the leadership’s track record and the post-IPO ownership structure

Metrics to consider:

• Management experience: Look at the experience and credibility of CEO, CFO, and other key executives

Step 6: Understand the company’s competition and industry risks

Considering a company has several challenges to tackle, it’s good to know deeper about the company’s standing as compared to the competitors and potential challenges

Metrics to consider:

• Market share: Does the company have enough market share in the industry

• Competitive advantages: Unique factors like patents, strong brand, or network effect

• SWOT analysis: To get a rounded view of risks and opportunities for the company

• Regulatory Risks: To analyse if regulations can possibly dampen the company’s growth, or worse, existence 

Step 7: Analyse investor sentiment 

Find out how the IPO is being perceived in the grey markets. Also look at price bands and the demands for the IPO in the markets.

Metrics to consider:

• IPO price range: Compare the proposed price range to similar companies in the industry

• Over/under-subscription: If the IPO is oversubscribed it indicates demand for shares

• Use of money raised from the IPO: How the company plans to use the money raised from the IPO (expansion, debt repayment, etc.)

• Analyst opinions: Read early coverage and reports from investment banks and financial analysts to make an informed decision 

• Grey market premium: GMP gives you an idea about investor sentiment and how the IPO may end up doing in the primary markets 

Step 8: Risk Assessment

These metrics help you understand the risks related to the company's business model, finances, and external factors.

Metrics to consider:

• Risks: Check the company's RHP to know about listed risks (market competition, supply chain risks, legal issues, et al)

• Volatility: Compare with industry competitors to understand how volatile the stock might be post-IPO

• Macroeconomic factors: Consider broader market trends, interest rates, and economic conditions that may affect the company's performance.

Top tips to remember when applying for IPOs - 

1. Never be hasty - Apply for the IPO at least a day after it goes live. Applying early does NOT impact your chances of allotment. 

2. Try and follow market buzz and grey market trends of the upcoming IPO. They can be significant indicators of how much listing gains the IPO may produce. 

3. Monitor the stock after the IPO. Not all IPOs are about listing gains. Doing a thorough research about the industry helps you identify IPOs that might not give listing gains, but are great stocks to own for the long term.