How to Evaluate an IPO: A Practical Framework for Investors

An Initial Public Offering (IPO) allows investors to participate in a company’s growth from day one. But in recent years, rising retail enthusiasm has often led to oversubscription, inflated pricing, and misplaced expectations. Evaluating IPOs with discipline is essential to avoid unnecessary risk and identify genuine long-term opportunities.

1. Understand the Business and Its Industry

Disciplined IPO investing starts with a clear understanding of what the company does and the environment it operates in.

Assess the Business Model

What products or services does the company offer, and how differentiated are they?
Who are its core customers?
Does the business have a competitive advantage such as technology, brand strength, cost efficiency, or distribution reach?
Can revenue scale without a proportional rise in costs?
Are there regulatory approvals or licences that influence operations?

A predictable, defensible business model improves the likelihood of sustainable long-term performance.

Evaluate the Industry Outlook

Even strong companies struggle in weak sectors. Consider:

Industry size, growth prospects, and demand drivers
Whether the sector is cyclical or structurally supported
Regulatory and policy trends
Competitive intensity
Structural themes relevant to India such as digitisation, consumption growth, or manufacturing incentives

Favour industries where long-term potential is supported by clear macro or policy tailwinds.

2. Review Financial Strength and Quality of Management

Financial performance and leadership quality directly influence a company’s ability to create value post-listing.

Analyse Financials

Key metrics to examine include:

Revenue growth over recent years
Profitability trends such as net margins and EBITDA margins
Cash flow generation—the ability to convert profit into cash
Debt levels and related ratios such as debt-to-equity and interest coverage
Return ratios including ROE and ROCE

Weak or volatile profitability warrants caution.

Assess Promoter and Management Quality

Strong governance is often a critical differentiator. Look for:

A consistent track record
Absence of regulatory concerns
Depth of the leadership team
Promoter shareholding that indicates genuine commitment

If promoter integrity is uncertain, it is prudent to avoid the IPO altogether.

3. Examine the Purpose and Pricing of the Issue

IPO pricing and the intended use of funds provide important clues about future value creation.

Evaluate IPO Valuation

Compare the company’s valuation—using measures such as P/E, P/BV, or EV/EBITDA—with listed peers. Consider whether projected growth justifies any premium. Grey Market Premium (GMP) can reflect sentiment but should not drive investment decisions.

Overpriced offerings often disappoint both at listing and over time.

Understand How Funds Will Be Used

The Red Herring Prospectus details whether proceeds will fund expansion, reduce debt, or support working capital. Be careful when:

A significant portion is an Offer for Sale, signalling promoter or investor exits
Expansion plans appear overly ambitious or loosely explained

A high OFS share means less fresh capital directed toward future growth.

4. Identify Key Risks

The risk section of the prospectus highlights vulnerabilities that could impact future performance. Pay attention to:

Dependence on a few major clients → Concentration Risk
Litigation or regulatory challenges → Regulatory & Legal Risk
Reliance on key individuals → Key Person Risk
Commodity price volatility → Input Cost Risk
Foreign exchange exposure → Currency Risk
Technology disruption → Technology & Innovation Risk
High working capital requirements → Liquidity Risk

More concentrated risks require a higher margin of safety.

5. Manage Expectations and Allocate Prudently

IPOs attract significant attention, but expectations must remain grounded.

Understand Allotment Dynamics

Retail allotment is based on a lottery system
Oversubscription does not guarantee gains
Strong institutional demand can be a quality signal

Avoid relying on market rumours or sentiment indicators.

Avoid Speculating on Listing Gains

Treat an IPO as a long-term investment. Listing gains, if they occur, should be a bonus rather than the core objective.

Follow Disciplined Position Sizing

Limit IPO investments to a modest share of your equity portfolio
Avoid leverage
Maintain diversification rather than concentrating in hyped sectors or themes

IPOs carry higher uncertainty than established listed businesses and should be approached accordingly.

6. Avoid Common Red Flags

Be cautious when you notice:

A sudden spike in revenue or margins just before the IPO (as seen with Lenskart recently)
Inconsistent or aggressive accounting practices
Frequent changes in auditors
Heavy related-party transactions
Rapid expansion into unrelated business lines
Frequent turnover in key management positions
High promoter share pledging

These red flags signal higher uncertainty and warrant deeper evaluation before investing.

7. Focus on Long-Term Value Creation

Before investing, ask:

Will the company be stronger five to ten years from now?
Does it have a meaningful runway for growth?
Are the promoters committed to scaling responsibly?
Is the valuation reasonable for long-term wealth creation?

A long-term mindset helps differentiate between temporary excitement and businesses capable of compounding value.

Conclusion

A disciplined IPO approach blends business understanding, financial analysis, valuation clarity, and thoughtful risk management. By focusing on strong fundamentals, sensible pricing, clean governance, and industry potential, investors can identify offerings that add genuine long-term value—not just near-term excitement.