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Check List for Investors - Views on News from Equitymaster
 
 
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  • Jun 21, 2000

    Check List for Investors

    The Initial Public Offering or IPO market as it is known, received a new lease of life in FY99. With high profile issues like Hughes Software and TV-18 opening at more than 3 and 10 times their issue price respectively, investors are flocking to the IPO market like never before. Companies, which had earlier shied away from the capital market, are now returning with a vengeance to satiate the appetite of investors.

    Some of the over-subscription details of recent IPOs are mind-boggling: TV-18 by 51 times, Glenmark by 55 times and HCL technology by 27 times. Other software issues like Hughes and Polaris Software have been oversubscribed by 15-20 times. The reason for this enthusiasm can be attributed to the software boom that markets have witnessed over a past year or so.

    But should one just jump for an IPO as soon as it is announced? Here an attempt has been made to outline some issues that investors should look at before they making investment decision.

    Before investing in an IPO, investors are suggested to run a check on the following factors:

    • Who are the Lead Managers to the issue? Do Lead Managers act as an indicator of the quality of the issue?

      The Lead Managers act as a catalyst as they attempt to bring in some credibility to the offer and their accountability is also very high. Remember that the lead managers’ credibility could act only as an indicator to the proposed issue, but does not assure success. There have been poor issues from good merchant bankers in the past.

      For the purpose of security, one can look for category one lead managers for judging the quality of the issue that includes DSP Merrill Lynch, HSBC Securities and Kotak Mahindra among others.

    • What is the promoter holding in the company? Is there any participation from financial institutions or a venture capital firm?

      Issues where post-issue promoters’ holding is more than 80% may indicate a lack of liquidity in the stock since there are fewer shareholders trading fewer shares.

      Be careful of companies that have issued shares on a preferential basis to promoters in high proportion, so as to increase their stake in the company. Also find out if this is an offer for sale or a genuine Initial Public Offering. In case of offer for sale, the issuing company may not benefit totally.

      Look for companies in which venture capital firms or financial institutions have participation or substantial interest. Also look for the shareholding pattern. This would indicate the risk profile of the company and the expectation of the institution from the company. In case of institution, look for nationalized banks and all India level financial institution such as ICICI, IFCI IDBI etc.

      Be careful of companies whose cost of project and means of finance have not been appraised by banks or financial institutions.

    • Where is the company investing my money? Is it going to give me good returns?

      If the major portion of fund mobilized is being invested in land, buildings (the so-called green field issues) be careful.

      If the company is utilizing a portion of issue proceeds towards retiring high-cost debts, it would benefit the company in terms of lower interest outflow and therefore higher profitability. Also check the proportion of money that is being invested in new projects that it is venturing into. This would give some judgement on the estimated profitability of the company.

    • Which sector does the company operate? What is the growth prospect of the company vis-à-vis the sector?

      The growth of the company in proportion to the growth of the market in which it operates has to be seen. Also look out for its market share or the projected market share vis-à-vis domestic competition. For example, figures of global software market or Indian software market do not indicate the exact future growth potential of the company since it is inclusive of all products and services. Export projection of the sector need not necessarily reflect the export potential of the company. See what the company is exporting and export income as a percentage of sales.

      Each sector has its own internal and external factors that influence the operation of the company. For example, software sector is vulnerable to high employee turnover.

    • Do the promoters have enough experience?

      Do the promoters have previous experience in transforming organizations from the grass root level in the same industry to a successful business? What is the experience they have in the sector the company is operating in or any other sector. Promoter experience is very crucial.

      Also check out the profitability of any subsidiary or affiliate company in which promoters have a stake or substantial interest. This would enable us to ascertain the management’s efficiency in terms of managing organizations.

      Check for litigations against the promoters, nature of litigation and the promoter’s extent of liability, if any.

    • Will the money invested yield maximum returns? Are the profit projections achievable?

        Ask yourself these questions:
      1. What is the sales growth projected by the company vis-à-vis others in the sector and the industry growth rate? If the market is growing at 20%, it does not mean that the company would grow by 20%. Let’s take a hypothetical example. X Company manufactures paints. Assume that the market is growing at 12% per annum. If sales of the company grew by, let’s say 6%, it means that the company is growing at the rate of 0.5 x the industry growth. This would help you in ascertaining growth potential of the company.
      2. Are the margins projected comparable with other companies in the same sector?
      3. Is there any unusual costs or unusual rise in other income (recurring/non-recurring)? Some companies show an unusual rise in their sales and net profits by 5-10 times. Justify this by comparing the sales growth figure.
      4. Check the competitive scenario of the industry. If the company is claiming that it is competing with e-enabled service providers, check out what type of e-enabling services they provide. Addressing competition at a macro level may reflect the exact picture.

    • How do I justify the price of the issue?

      To justify pricing,
      Compare:

      1. The price to earnings ratio (this is price that the issue is offered upon earnings per share) which would throw light on the pricing of the issue.
      2. operating margins (this is the income from operation less expenses from operation),
      3. Market capitalization (it is the number of share multiplied by the price at which it is offered) with the current companies in the sector that are listed in the market.

    • Does the company enjoy tax benefits?

      Companies with foreign exchange earnings are entitled to certain exemptions. If the company’s factory is in backward regions, they are entitled for subsidies as well as some tax exemptions. Lower incidence of tax benefits companies as their cash flows are increased to that extent.

      The ultimate ‘Watch word’
      Caveat Emptor! Buyer Beware. This should be the watchword for investors. Any company may opt for an IPO. But, ultimately it is your hard-earned money that is getting diverted into unproductive investments, which may not give you the required return.

     

     

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