In our previous videos, we have discussed the IPO (Initial Public Offering) and the reasons to invest in an IPO.

In our previous videos, we have discussed the IPO (Initial Public Offering) and the reasons to invest in an IPO. So, we start this video with a simple question, why does a company issue an IPO? A company issues an IPO when it wants to raise capital from the equity market, which it intends to utilise in various ways.

Now to do so, the company needs to form a DRHP for SEBI. Now, what is DRHP? DRHP or Draft Red Herring Prospectus is a preliminary prospectus which is submitted to the SEBI by the company (issuer), containing the details about the upcoming issue and the company. To a layman, it is like a document which details all aspects about the company, the sector in which it operates, financial performance in the past, why it needs funds, what will it do with the funds and every other detail which can help one decide whether to invest in the IPO or not.

The Red Herring Prospectus is a report with 500 pages, containing the details of the IPO. For a layman or a novice investor, it is a tedious task to go through the entire report. Even if someone makes an attempt, reading a red herring prospectus can be confusing to start with. To remove the confusion, in this video we will discuss the few broad areas which an investor should go through before taking any investment decision:

First, to know about the company and the Industry – Similar to buying any product or service, for which you go through every detail, it is also necessary to know about the company you would invest into.

For this, we have to go under the “About the Company” section, wherein we will get all the details regarding the company, to have the conviction to buy and hold for a long term.

Here, you need to check: Business Model Industry Structure How it functions, and Entry barriers for the business, strengths & weaknesses, competition, Management etc. Next is Going through the Financial Information Section. Here you need to check: Whether the company is generating top line growth from the past 5 years, if it has a history, along with bottom line growth from the “Income Statement”.

Then, coming to the “Balance Sheet” we need to check the Capital base as well the Debt levels, pre and post IPO. A debt driven company may not be a lucrative investment option. The Cash Flow Statement, whether the company has been able to generate cash over the years. The “Objects of the Offer” section: IPOs can be raised for various reasons.

Under this section we can get to know the details of the IPO and how the company is planning to use the money. Most common reason is to do Capex activities, which is understandable, according to the ROE of the company. Promoter Group shareholding pattern: Here we have to check how the promoters are adjusting with their shareholding post the IPO issue. Partial reduction in the Promoter’s holding to meet regulatory requirements is normal.

But one should keep a close watch on whether the promoter is reducing the stake substantially without any regulatory needs. Apart from this, do check the “Legal & Other Information” section to see if there are any disputes against the company to be cautious of any legalities. So, like you saw, there are quite a few points which need to be checked in order to safeguard ourselves from any type of fraud. It is important to utilise the RHP or the Red Herring Prospectus, as it is a wealth of information regarding the company, so that we can get to know as much as we need to.

One can also read a summary report of the IPO of good companies, published by reputed research houses and brokers. These reports are a good way to understand the nuances and finally arrive at a decision whether to subscribe to it or not.