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Practical and easiest way to select Fantastic IPOs

  • 12:56 am

IPOs are always exciting and surprising for the investor whether it is Paytm, Zomato or LIC. Retail customers are always attracted by these companies with good marketing, although many companies file IPOs in the market. Let’s understand how we can analyze the upcoming IPOs. We have tried to make it very crux and to the point.

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    Understand the Business Model

    Understanding the business model of any company is always tricky nowadays. I don’t want you to put into the bulk of notes to understand the business. As we as retail investors can’t do the lengthy research. So we have divided it into a few simple pointers.

    Core Business:

    • What does the company do? This is the fundamental question. Is it a product-based company, a service-based company, or a combination of both?
    • Example: (Product-based company) A technology company might develop software solutions, (Service-based company) while a retail company might sell physical products.

    Revenue Streams:

    • How does the company make money? Are there multiple revenue streams or a single primary one? And what are the primary and secondary sources of the company?
    • Example: A software company might generate revenue through software licenses, subscriptions, and consulting services. But here licenses can be their primary source of income.

    Customer Base:

    • Who are the company’s customers? Are they individuals, businesses, or both? In corporate terms is it D2C or B2B company?
    • Example: A social media platform might have a large individual user base, while a business software company might target corporate customers.

    Value Proposition:

    • What unique value does the company offer to its customers? This is often called the company’s “USP” or unique selling proposition.
    • Example: A streaming service might offer a vast library of content and personalized recommendations. Or a chips company can claim the unique flavours of chips as their USP.

    Competitive Landscape:

    • Who are the company’s competitors? How does the company differentiate itself from its rivals? The completion in the market.
    • Example: A smartphone manufacturer might compete with other brands based on features, design, and pricing.

    Scalability:

    • Can the company grow its business efficiently? Is it capable of increasing revenue and profits without proportionally increasing costs? Is the sector in which the company is working growing or not? Every company needs space to grow.
    • Example: A subscription-based software company can often scale easily by acquiring new customers.

    Growth Strategy:

    • How does the company plan to grow in the future? Is it focused on organic growth, acquisitions, or a combination of both?
    • Example: A retail company might expand by opening new stores, while a technology company might acquire smaller businesses to gain access to new markets.

    Financial Statements

    Financials statements always sound scary to People with non finance background. As it includes a lot of difficult terms and lengthy entries. So we have divided it into a few pointers that need to be checked on:

       Revenue: Look at the company’s revenue growth over the past few years. Are they consistently growing, or are there fluctuations?

       Profitability: Check for profits or net losses. Early-stage companies may not be profitable yet, but examine their path toward profitability.

       Cash Flow: Understand the company’s cash flow to see if they are generating enough cash from their operations to sustain growth.

       Debt Levels: Evaluate the company’s debt burden. A highly leveraged company might pose a risk, especially in uncertain market conditions.

       Expenses: Check the operating and capital expenditures to ensure the company is efficiently managing costs.

    Let’s see them in numbers here-

    Financial Ratios

    • Price-to-Earnings (P/E) Ratio:
      • Generally: 10-20 is considered reasonable. However, high-growth companies might have higher P/E ratios.
      • Industry-specific: Compare to industry averages.
    • Price-to-Book (P/B) Ratio:
      • Generally: 1-2 is considered reasonable.
      • Industry-specific: Varies depending on the industry. For example, companies in the financial sector might have higher P/B ratios.
    • Debt-to-Equity Ratio:
      • Generally: Less than 1 is often preferred, indicating a stronger financial position.
      • Industry-specific: For example, capital-intensive industries might have higher debt levels
    • Revenue Growth: Consistent growth of 15-20% or more is generally considered positive.
    • Profit Margins: Improving profit margins over time are indicative of a healthy business.
    • Management Team: A strong and experienced management team with a proven track record is crucial.

    IPO Valuation

     Factors and Ratios for IPO Valuation

    When evaluating an IPO, it’s essential to consider both quantitative and qualitative factors to determine its fair value. Here are some key factors and ratios:

    Quantitative Factors and Ratios:

    • Price-to-Earnings (P/E) Ratio:
      • Measures the market value of a company relative to its earnings per share.
      • A lower P/E ratio generally indicates a more undervalued stock.
      • Ideal Range: Varies by industry and market conditions, but generally between 10-20 is considered reasonable.
    • Price-to-Book (P/B) Ratio:
      • Compares a company’s market price to its book value per share.
      • A lower P/B ratio might suggest undervaluation.
      • Ideal Range: Varies by industry, but generally between 1-2 is considered reasonable.
    • Price-to-Sales (P/S) Ratio:
      • Measures a company’s market value relative to its revenue.
      • Often used for companies with negative earnings or in early-stage industries.
      • Ideal Range: Varies by industry, but generally below 2 is considered reasonable.
    • Dividend Yield:
      • Measures the annual dividend per share as a percentage of the stock price.
      • A higher dividend yield can be attractive to income-seeking investors.
      • Ideal Range: Varies by investor preferences and market conditions.
    • Market Capitalization:
      • The total market value of a company’s outstanding shares.
      • Can be used to assess the size and relative importance of a company within its industry.
      • Ideal Range: Varies by investor preferences and market conditions.

    Qualitative Factors:

    • Company Fundamentals:
      • Business model, competitive advantage, management team, financial health, and growth prospects.
    • Industry Outlook:
      • Growth potential, regulatory environment, technological advancements, and competitive landscape.
    • Market Conditions:
      • Overall market sentiment, economic conditions, interest rates, and geopolitical factors.
    • IPO Pricing: Is the IPO priced at a premium to the company’s pre-IPO valuation?
    • Lock-up Periods: How long will insiders and early investors be restricted from selling their shares?

    Check if there is a lock-in period after the IPO, during which insiders can’t sell shares. Large-scale insider selling after this period can be a red flag.

     Example:

    Zomato IPO: In 2021, Zomato’s IPO was highly anticipated. Investors analyzed its business model (food delivery), financials (operating losses, but high revenue growth), and industry potential (growing food tech market). Although not profitable, Zomato was viewed as a high-growth company with a significant market share.

    • Float Size: What percentage of the company’s shares will be available for trading?

    By carefully analyzing these factors and ratios, you can make more informed decisions about whether an IPO is a suitable investment for your portfolio.

    • Scalability: Assess how easily the company can scale its operations.

     

    You can also go through for more: simple-steps-to-select-the-best-stocks

    Important Ratios

    Here’s a summary of the ideal ranges for key financial ratios. Keep in mind that these ranges can vary by industry, so it’s important to compare with industry peers:

    Profitability Ratios

    Net Profit Margin: Ideally above 10%, but can vary by industry.

      – Higher margins indicate more efficient cost control.

    Operating Profit Margin (EBIT Margin): Ideally 15% or higher.

      – Indicates good operational efficiency.

    Return on Equity (ROE): Typically 15%-20% is considered good

      – Higher ROE shows better use of shareholder equity.

    Return on Assets (ROA): Ideally 5% or more.

      – Higher ROA indicates better utilization of company assets.

    Liquidity Ratios

    Current Ratio: Ideally between 1.5 to 2.

      – A ratio below 1 indicates liquidity issues; above 2 might mean excess assets.

    Quick Ratio (Acid-Test Ratio): Should be 1 or above.

      – A value of 1 or more means the company can cover its short-term liabilities without relying on inventory.

    Solvency (Leverage) Ratios

    Debt-to-Equity Ratio: Below 1. A ratio above 1 means more debt than equity, which can be risky.
    – Interest Coverage Ratio: Above 3. This shows the company can comfortably cover its interest payments.

    Valuation Ratios

    Price-to-Earnings (P/E) Ratio: Typically 15-25. A high P/E suggests growth expectations, while a low P/E might signal undervaluation or financial issues.

    Price-to-Book (P/B) Ratio: Between 1 and 3. A P/B ratio below 1 could indicate undervaluation, while above 3 might suggest overvaluation.

    Price-to-Sales (P/S) Ratio: Below 3. A P/S below 1 may indicate undervaluation, while above 3 might suggest the company is overvalued.

    Efficiency Ratios

    Asset Turnover Ratio: 1 or higher. A higher ratio indicates efficient use of assets to generate revenue.

    Inventory Turnover Ratio: Between 5-10, depending on the industry. A high turnover reflects efficient inventory management.

    Growth Ratios

    Earnings Growth Rate: 10%-20% year-over-year. High growth is good, but it should be sustainable.

    Revenue Growth Rate: 10%-15% annually. Indicates strong company growth.

    Dividend Ratios (if applicable)

    Dividend Yield: 2%-5%. Higher yields may indicate a mature company, but very high yields can be unsustainable.

    Dividend Payout Ratio: 30%-50%. A high payout ratio above 60% can limit the company’s ability to reinvest in growth.

    Conclusion

    And there you have it: a complete guide to analysing IPOs like an expert! You now have the tools and expertise to make sound investing decisions and navigate the fascinating world of initial public offerings.

    Remember that investing in IPOs requires study, analysis, and strategy. Understanding a company’s business model, financials, valuation, and industry trends allows you to make informed investment decisions that correspond with your financial objectives.

    Of course, no investment is completely risk-free, and IPOs are no exception. But by doing your due diligence and staying informed, you can minimize those risks and maximize your returns.

    So go ahead, dive into the world of IPOs with confidence.