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Prospectus-Things that You need to Know Before Investing

    Mr. Shyam | Friday, December 04,2009, 07:38 PM
 

Prospectus is a legal declaration that a company makes for an initial public Offering. This is a gateway for investors to get overall information about the company, everything about a company right from the type of business that they are into, their business model, their financial performance, board of directors, promoters, their branches, products, competitors, their marketing strategies etc. is given in the Prospectus. The prospectus is submitted to SEBI for its approval for IPO then it is open for public viewing. Most of the times prospectus is not less than 100 pages now the question is should an investor go through each word of each page to decide whether to invest or not, if yes then it would call for lot of time, concentration, patience of an investor. So we will be discussing some of the points which can give you a clear picture of the company without going through each and every word of prospectus.

Before starting to read the prospectus what I would tell the investors is;

  • Don’t invest your valuable money in the business model you don’t understand this is one of the golden rules that Warren Buffet has adapted and it has worked out successful for him. For example if you don’t understand the bio-technology business then think before investing in it. You may say that it has good returns then one of the risk that you are taking is you don’t know the business model hence it is evident that neither you know the strengths and weaknesses related to that business. Just in case you invest in that company and the whole industry enters into recession.
  • While reading have a skeptical view. Read it with concentration and do not just go by the name of the company
  • You may be lured by the company name but if you are speculator who is just looking to make some money through capital appreciation then do go through the history of trading prices of shares of that particular company of course this would be applicable for FPO only.
  • Whatever questions you might get make sure that you get them clarified. Be it the silliest or smallest. If you are getting too many questions then it is better to write it down in a paper to avoid forgetting them.
  • Act like a critic while reading the prospectus. Don’t have any biased view.
  • If you have any friends or relatives who have been investing in the stock market then please have a round of talk with them about the IPO of an upcoming company. This way you will be able to get a lot of information about the company.
  • Never go by name of the company.

Things that you need to know before Investing

  • Know about the company
  • Where to begin
  • Price
  • EPS
  • Capital appreciation
  • Risk factors
  • Capital structure
  • Management
  • Legal aspects
  • Report of auditors
  • Marketing strategy
  • Financials

Know about the company


The first step would be to get a Prospectus from the underwriter. Hard copy is preferred as we are always used to it. If you are tech-savvy then no problem you can get the prospectus in the electronic form and read. Let it be in any form most important thing is that you have it. Before getting the prospectus make sure that you know something about the company at least about the industry. Why I am insisting about this is because in case you are a speculator an you suddenly see that an IT company is coming up with an IPO you should not jump and apply for the shares and buy them. If you know about the company or industry you can analyze the present economic situation and can quickly come to know whether the economic conditions are conducive or not. Of course there is a rule that everything in the long run will increase its price but how patient we are and long are we will be holding the stocks?

Parts of the prospectus
Prospectus is divided into many sections they are;

Section-1: General
Section 2: Risk factors
Section 3: introduction
Section 4: about the company
Section 5: Financial Statements
Section 6: Legal and other Information
Section 7: Issue information
Section 8: Main Provisions of the Articles of Association
Section 9: Other Information

Where to begin


Prospectus is very bulky in nature. It is divided into many sections as shown above. Now the question is from where should an investor start reading it? I would say it would be appropriate if an investor begins with the section 4. There is a reason behind this as investors are having their own choices or avenues of investment. If an investor is interested in minerals and Power Company and is least interested in Agro based companies, it would be foolish and waste of valuable time and energy if he starts from the page 1 and after he reaches the 4th section he comes to know that it is not the area of his interest and stops reading prospectus.

If a were the investor the methodology that I would have followed is first read section 1, then introduction, followed by risk factors, financial information, issue information, legal information and so on.

Now the above process is highly subjective and there is no rule that every investor has to follow this process only because perception of every investor and need for the moment is different. For example an investor must be too worried about the risk factors irrespective of company then he may start with 2nd section and if he is too much interested in dividends and earnings per share then he can start with the dividend policy or financial information section.

Price


Please go through the pricing strategy followed by the company. If you have any idea about the share prices of similar companies belonging to same category then compare the prices. This is done in order to find out if the share is undervalued or overvalued. Also read and understand what clarification company is giving for their price band and evaluate it.

EPS


It is an acronym which stands for Earnings per Share. If you are an investor who expects better dividends then this is one thing which you will have to look for before making a decision. Just go through the financial dividends and dividend policy of the company it would largely make you aware of the dividends distributed by company.

Capital appreciation


If an investor is looking for a long term investment is not bothered about what dividends he gets then he will be looking for capital appreciation. It is nothing but increase in its monetary value over the time; this can be roughly estimated using the growth rate which the company has been able to achieve over the past few years. It should be noted that growth is an indicator and by that we are trying to predict that the company would be continuing with same growth rate and if it is a startup company the figure company can be misleading as startup companies have a high growth rate early in their life which reduces and stabilizes as time passes by.

Risk factors


This is one area which any investor cannot even think of neglecting. Companies will have listed many parameters from finance and economy which are considered as risk factors for their business. Go through them and match it with your analysis, what does your intuition or your analysis indicate? Whether it says that the risks can be easily overcome and business will be able to make profit or it is otherwise. Take your decision on that.

Capital structure


Capital structure is one of the indicators of company’s leverage. Try to find out if it is over-leveraged or under-leveraged. Both are not good for a company. If the company is over-leveraged then be careful before investing in that company because company will have undergone a memorandum of understanding in which lenders will have put various conditions. Suppose company does not adhere to those conditions then action will be taken on that company.

Management


Board of directors and promoters are very important as they are the one on whom the investor will be dependent and they are like a guarantee for the investors. Check what experience they bring in to the company and what their fields of expertees are.

Legal aspects


This is also an important part of prospectus which has to be looked out. Try to find out if the company has been found guilty in any instances by the law. Try to find if the business that they are doing has any constraints or restrictions put forth by law.

Report of auditors


Just find out who are the auditors and their worthiness. This has become very important especially after the Satyam saga. It’s because will you be ready to put your money in one company if their auditors are Price Water house.

Marketing strategy


If you have a fair idea of the market and market requirements then just go through this section you will get a lot of information about the strategy that the company will be following in the coming years and as I said if you have a fair knowledge then you can evaluate the strategies and find out if they will work out or not.

Financials


Go through the financial statement of the company find out what’s the percentage growth in profits, are they increasing in the same manner as the operational cash flows? And what is the increase in the sales year wise. This is called as crunching the numbers. Crunch the numbers as much as possible so that you get a fair idea of the company’s financial performance.

Present scenario


This year since April there are around 15 companies which have gone for IPO and you will be surprised to know that out of them shares of only 5 companies are trading above their issue prices and rest of them are trading below that. Now if you are a speculator what would be your reaction to this or just imagine you are an investor and you need quick money what would you do? If you think of selling the shares of these companies then you will be experiencing a capital loss.

Company

Issue price

Closing price as on 4th Dec

Adani Power Limited

100

96.60

NHPC Ltd

36

31.95

Indiabulls Power

45

33.00

Euro Multivision

75

31.85

Den Networks

195

173.95

Mr. Shyam

IndianMoney.com Research Associate

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