Investing in an IPO: Why should you buy?

This last year, when the stock market was going through a roller coaster ride, the initial public offering (IPO) came in the limelight again.

In succession, when businesses are queueing up to procure money from the market in the course of high valuations in the stock market, one needs to take into account numerous things ahead of investing their money in an IPO.

Investors generally believe that the stock prices of the company would most probably increase after it has launched its IPO. Hence, they hurry to subscribe to value stocks of companies with firm fundamentals at an affordable price.

Often, a basic question arises amongst such investors, "Why should we invest in an IPO?"

Let's take an example to show the importance of an IPO for prudent investors -

Warren Buffett, perhaps the most successful investor, is one such investor who missed the IPO opportunity. Buffet at no time invests in IPOs and is doubtful of tech companies. So, when Jeff Bezos issued the Amazon IPO in 1997, Buffet let the offer go away. During that time, Amazon was a forthcoming online retailer selling mostly books.

Many other investors showed to be wiser than Buffett — at least in this specific case. That Amazon IPO made Bezos, the owner of Amazon, now richer than Buffett. And later on, Buffet admitted his gaffe.

So, let's dive into the topic and understand the whole thing:

Why Do Companies Offer IPOs?

Companies collect money from the stock markets through an IPO with the purpose of raising capital, which could be directed for various business requirements like size expansion, product diversification, entry into a new market, a major R&D idea, amalgamation and acquirement action etc.

The issue prospectus mentions the proposed usage of funds. The benefit for a company to collect money through an IPO over other financing methods such as loans etc. is more prominent in the market and has a better chance to expand its market capitalization.

What Are the Different Types of IPOs?

Mainly the different types of IPOs include:

New Offer

In a new IPO, a company raises funds for the very first time from the stock market and gets the shares listed on the stock exchange. This leads to an increase in the number of shareholders of the company and injects the raised funds into the company.

Follow-On Offer

In a follow-on-order, a company is already listed on the stock exchange, and its shares are being traded in the stock market. Still, when the company wants to raise further funds through the IPO channel, it is known as a follow-on-offer.

Offer for Sale

In an offer for sale situation, the existing promoters sell their shareholding through an IPO. Many government companies do disinvestment majorly through this method. This is done to change the shareholding pattern. For instance, in the recent past, IRCTC issued OFS to change the shareholder's pattern to comply with SEBI's rule.

Why Should an Investor Consider Buying IPO Shares?

Investors bid the money in an IPO issue and become shareholders of the company.

Following are the benefits of investing in an IPO:

Get in on the action early

By putting your money in an IPO, you can join the 'ground floor' of a company with huge progress. An IPO can be your opening to a quick profit in a short time. IPO can also help you in growing your wealth over a prolonged period. 

Presume, you invest in a new company that sells a unique kind of technology. If it succeeds in capitalizing the market and makes in profits, you would also gain from its achievement.

Meet long-term goals

IPO investments are mainly equity investments. Therefore, an IPO has a huge potential to give back big gains in the long run. The amount received can help you in realizing your long-term financial goals such as retirement planning or buying a house.

Besides, the Indian IPO market is growing. In 2017, the Indian stock market generated almost $11 billion through IPOs.

More price transparency

The price per security issued is stated in the IPO prospectus. So, even retail investors have an approach to a similar report as larger investors.

When the shares get listed, the share price will depend on changing market rates and the best price that the stockbroker can offer.

Buy cheap, earn big

The IPO share price is habitually the lowest if you put in in a small size company that has a huge possibility to grow big in the future. That is because the company may offer a discounted price in an IPO. If you neglect the IPO, investing in that capable company may be hard and expensive since the stock price may climb sharply.

Let's take Amazon's example. When Amazon.com Inc. issued an IPO in 1997, the share price was $18. If you would have invested $5,000 in the Amazon's IPO, your shares worth would have been $2.5 million in April 2018.

Why are companies lining up for IPOs?

The IPO market is anticipated to behold some exciting names, comprising the so-called mother of all IPOs, LIC, and the NSE, in the approaching months. Other names contain Kalyan Jewellers, Bajaj Energy and Barbeque Nation. 

The major cause propelling companies to the IPO market is the ongoing bullish stock markets, which has driven the Sensex to an all-time high of 48,000. A robust market suggests that a respectable company can get a good valuation.

It has also allowed various venture capitals and private equity funds to exit from companies that they funded and cash-in their share in the company through the IPO. SEBI (market regulator) has fine-tuned the principal market rules, thus allowing the issuers to sail an IPO and list the shares of the company in a very short time, thus reducing costs. 

The triumph of IPOs has provoked many latent issuers to look at the IPO market for fund-raising and listing in the stock market as the investor attitude is positive.

Closing Words

IPOs present some of the major opportunities to generate a fortune. Some evolving companies can change your portfolio forever. When you find a winning company, just relax and adore the expansions on your investment.

But one should always remember that every IPO doesn't perform well. They can fall without an indication as well.

Hence, as we always say, invest wisely!