Big IPO, no guarantee of big earnings! Understand the real game of valuation before investing

Whenever a big IPO (Initial Public Offering) comes in the market, it creates a different buzz all around. There is a competition among retail investors to buy it. People think that the bigger the company, the stronger will be the listing gains and future profits. But the history of the stock market is witness to the fact that every big IPO is not a guarantee of earnings. Many times the saying ‘high shop, dull food’ proves to be true. Before entering the investment race, you have to deeply understand the mathematics of valuation behind it. Difference between brand shine and reality: Often big companies create hype in the market on the basis of their brand value and heavy advertisements. Investors are attracted by the name of the company and its large size. But the truth is that large size only reflects the company’s expansion, not its profitability. Many times startups or new tech companies launch IPO at huge valuations without earning any profit. In such a situation, if you are investing money just by looking at the name, then you may get a big shock on the day of listing or after. The mathematics of valuation which is important to know: Before investing money in any IPO, it is very important to look at the PE Ratio (P/E Ratio), Price-to-Book Value (P/B Ratio) and Return on Equity (ROE) of the company. If a company is offering shares at very expensive valuations compared to its peers, it means that future growth is already being priced in. In such a situation, there is no earning margin left on the table for retail investors. There is a simple rule – IPOs with expensive valuations have very little scope for listing gains. Do not rely on Gray Market Premium (GMP) Nowadays, new investors completely depend on Gray Market Premium i.e. GMP to place bets in IPO. Remember, GMP is not an official figure, it is merely an estimate and the immediate sentiment of the market. Many times the GMP of a big IPO is shown very high initially, but on the day of listing it falls drastically as the market mood or global cues change. Therefore, take the decision not by looking at GMP but by looking at the fundamentals (financials) of the company. What should retail investors do for safe investment? If you want to protect your hard-earned money, read the company’s Red Herring Prospectus (RHP) instead of falling prey to big IPOs. See where the company is going to use the money raised from the IPO. If the money is being used to repay the loan or expand the business, then it is a good sign. But if the existing promoters are exiting just by selling their stake (OFS – Offer for Sale), then you should be alert. It is wise not to consider everything that glitters as gold and press the ‘Apply’ button only after understanding the mathematics of valuation.