Explainer: How to distinguish speculation from investment in IPO bets

With over 90 IPOs hitting Dalal Street this year, the temptation to join the frenzy is strong. But in markets, discipline outweighs excitement. A simple 90-minute self-audit—downloading the DRHP, analysing ratios, and comparing peers—can save you from costly mistakes with your hard-earned money.

If most of an IPO is OFS, you’re financing someone’s exit, not the company’s growth.

India’s initial public offer or IPO market is booming. For many retail investors, it’s challenging to decide whether to apply, avoid, or observe. The answer isn’t found in market noise. It’s in asking smart questions—and doing a few simple calculations—before risking your savings, says Venkatachalam Shunmugam.

Where is my money actually going?

Every IPO splits into two buckets.

Fresh Issue: The company receives new money to expand, repay debt, or invest in technology.

Offer for Sale (OFS): Existing shareholders—founders, venture funds, or private investors—are selling their stake. This money doesn’t go to the company; it goes to them.

If most of an IPO is OFS, you’re financing someone’s exit, not the company’s growth. Check the prospectus—available for free on the Securities and Exchange Board of India (Sebi) website or stock exchange portals. If less than 30% of the issue is fresh capital, pause and ask: Why are insiders rushing to cash out now?

Is the price reasonable?

Extract three years of revenue and net profit from the prospectus and compute the Price-to-Earnings (P/E) ratio.
Now compare this with similar listed companies. If the IPO trades at 200x earnings while peers trade at 40–50x, you’re paying five times more for the same rupee of profit. Unless growth is spectacular, that’s overpaying. Remember, when an IPO is priced as if everything will go perfectly, even a small mistake, a new competitor, or a market slowdown can significantly harm investors.

Can this business actually make money?

A company’s margins tell you how much of every rupee earned turns into profit. Gross margins above 60% indicate strong pricing power. Declining margins, even as sales increase, signal rising costs or a decline in competitiveness. A declining net margin—such as a drop from 6% to 2%—indicates that the business isn’t growing profitably. Always chart three years of margin data from the prospectus.

Is the company in debt? 

Turn to the balance sheet. A Debt-to-Equity ratio above 2 means the company borrows twice as much as its own capital—dangerous if earnings dip. Below 1 is typically safer. An Interest Coverage ratio below 2–3x means the company struggles to meet interest payments—a significant concern. High debt with weak margins is a double blow; even mild downturns can hurt profitability.

How efficiently does it use money?

Profitability ratios like Return on Equity (ROE) and Return on Capital Employed (ROCE) reveal efficiency:
ROE or ROCE above 15% signals strong capital use; below 5% inefficiency. If ROE lags peers but the IPO demands a premium valuation, think twice.

What about size and scale?

FOR YOUNG OR loss-making firms, use Price-to-Sales (P/S) instead of P/E. If the IPO’s P/S is 10x and peers trade at 2 to 3x, it’s overvalued relative to revenue. Unless growth or margins significantly exceed those of its peers, avoid paying that premium.

Your checklist

Download the prospectus: Read “Business Overview” and “Use of Proceeds.” This helps you understand what the company actually does and whether your money is used for growth or to pay off old investors.

Extract three-year data: Revenue, profits, gross and net margins. This gives you a sense of consistency—whether the business is growing steadily or showing one-time spikes.

Calculate 5 ratios:  P/E at upper price band, gross margin, net margin, debt-to-equity, ROE. This allows you to judge if the IPO’s pricing aligns with its financial performance.

Find peers:  Compare these ratios to at least two listed companies in the same sector—preferably a well-known one. This allows you to see if the IPO is fairly valued or just overhyped.

Decide: Is the valuation premium justified by stronger performance — or just hype? If the numbers don’t add up, it’s better to stay out than chase a “hot” issue.

Red flags

• IPO dominated by offer-for-sale (insiders exiting).
• One-time profits from non-operational items (insurance claims, asset sales).
• Falling margins despite growing sales.
• High debt with weak interest coverage.
• ROE/ROCE is significantly below that of peers.
• Valuations implying flawless execution forever.

 
The reality check

With over 90 IPOs hitting Dalal Street this year, the temptation to join the frenzy is strong. But in markets, discipline outweighs excitement. A simple 90-minute self-audit—downloading the DRHP, analysing ratios, and comparing peers—can save you from costly mistakes with your hard-earned money. When you treat every IPO like a business, not a gamble, you stop chasing headlines and start thinking like an investor. Because in an IPO boom, math—not momentum—is your best defence.

Author:

Mr. Venkatachalam Shunmugam, partner, MCQube

This article was originally published in Financial Express.