What is an Initial Public Offering?
An initial public offering is the process of issuing shares to the public by a private corporation to raise new funds. The purpose is to fund the new development plans of the company. The “issuer” is the company which issues the IPO.
The IPO is conducted in the primary market whereas after it is issued, the shares can be traded in the open market which is known as the secondary market.
Why do companies go for IPO-Initial Public Offering?
- The companies issue IPO to raise funds to fund its existing business, new projects, infrastructural development or repay the loans.
- Building brand value is also one of the motives behind issuing the IPO.
- It helps to provide more liquidity to the employees and investors. The company can retain better management and skilled employees through liquid equity stock participation.
- IPOs are a good option to decrease the cost of capital for equity and debt.
- They result in increased transparency along with required quarterly reporting. It can usually help to receive favorable credit borrowing terms rather than a private company.
How is IPO share price calculated?-IPO Valuation
- The companies hire investment bankers to determine the value of the IPO share price. The financials of the company is studied to determine the ideal IPO share price. The following factors help to determine the IPO share price
- Demand
- The demand for the shares of the company is a major determinant for calculating share price. But the high demand doesn’t necessarily mean that the valuation will be high. A company will do the demand analysis before issuing the IPO.
- Industry Analysis
- Industrial analysis is important because it shows the overall performance of the industry. The IPO valuation will be compared to the valuation multiples assigned to the other publicly traded companies in the sector. The logic is the investors might be willing to pay the same amount for the new entrant as they are paying for other companies.
- Future growth plans
- The IPO valuation heavily depends on the company’s future development plans. The main motive is to fund new development plans. The successful IPO depends on how investors perceive these future development plans.
- Company’s business idea
- The valuation process also considers qualitative factors. For example, it may consider whether the company new product or service idea is revolutionary or not. The company’s innovative idea will also affect the valuation process.
- Company’s financial position
- The financial position of the company is a major determinant factor for determining the share price. The strong financial position will help to set the price higher.
- So, these are the factors which determine the IPO share price.
Is Initial Public Offering a good investment?
Yes, it is a good investment but investing in every IPO is not advisable. IPO remains one of the best and safest option for a beginner or long term investor rather than intraday trading. The investor should consider some important factors before making an investment. Being cautious is good before investing in the stock market.
- The investor should do the background verification of the company and look at the historical data of the company.
- They should check where the company is going to utilize the funds.
- The investor look at the future growth plans and the business ideas of the company.
The credibility of the investment banker should be checked. The investment bankers decide the IPO stock price. The ideal IPO stock price is neither overvalued nor undervalued.
Thus, IPO becomes a good option for investment in the stock market. You need a Demat account facility to subscribe to IPO.
You can also read our blog on Fundamental Analysis of Stocks to analyze upcoming IPO options and make a profitable investment.
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