Future Capital Holdings will list on the stock exchanges on February 1. Next week it will be the turn of the mega initial public offering, IPO, of Reliance [Get Quote] Power to list. Somewhere down 2008, the government-owned BSNL is likely to come out with the 'mother of all IPOs'.

In between you will have scores of IPOs by both small and big companies. IPOs, in short, have been a hot topic of discussion in recent weeks. This article takes a look at some important concepts which will help you invest wisely in IPOs.

Listing gains

The basic reason for investing in an IPO is that they are often under-priced (sold at a price lower than what its actual worth is). This means that they usually see significant increase in price on the first day of trading. These are known as listing gains.

There are many theories surrounding why such under-pricing occurs usually based on the conflict of interest between the issuing firm, say Reliance Power, the lead manager which handles the issue, say Enam Securities and investors, like you and me, and uncertainly about the true value of the firm.

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Of course not all IPOs are under-priced and there are some issues which do poorly after they are listed.

Applying for an IPO

IPOs are generally advertised prominently well before the issue date. The advertisement provides information about the brokers and banks having the prospectus and application form.

The prospectus contains important information about the business plans of the firm and its past financial performance. This is important because there is usually little public information about unlisted companies.

For issues above Rs 10 crore it is necessary to open a demat account where you will receive any shares you are allotted.

Book-building

For issues above Rs 100 crores shares are issued through book-building which is a process of price discovery. Buyers are divided into three categories: qualified institutional investors (mutual funds, banks etc.), non-institutional investors or high net worth individuals (companies, wealthy individuals) and retail investors. Each category is reserved a certain percentage of the issue.

The company declares a price band, say Rs 225 to Rs 260 in case of Wockhardt Hospitals Limited, between which investors must bid. Based on those bids the company will determine the issue price. The number of bids will also determine whether the issue is oversubscribed which in turns determines how many shares you are allotted.

Dealing with oversubscription

Oversubscription is a huge problem for prominent IPOs like Reliance Power. This means that investors will only get a fraction of the shares that they apply for and it also means that your money will be unavailable until you receive your refund.

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One possible strategy is to wait till the last day or two before investing in an IPO. That will give you an idea how much the issue is oversubscribed and whether it's worthwhile to apply. Such information is easily available at the National Stock Exchange, NSE, website and will often be reported in the media for high-profile IPOs.

For retail investors the maximum investment limit is generally Rs 1 lakh. If an issue is oversubscribed more than 10 times, you will probably get less than Rs 10,000 worth of shares which may not be worth the hassle. For example the Reliance Power IPO was oversubscribed 10 times on the first day itself.

As per the latest news Reliance Power has decided to allot 43 lakh 15 shares each to retail investors because of huge oversubscription.

Not all high-profile are oversubscribed to that extent. For example the biggest IPO of 2007, DLF was oversubscribed just 3.45 times. The issue price was Rs 525 and the stock reached around Rs 1,000 in just a few months giving investors quick profits.

Another possible strategy is get multiple family members to apply for the IPO though each will need to open a demat account first.

Sources of information

In addition to the prospectus a lot of useful information is available on the web including the BSE and NSE websites. For example you can obtain information about how much a current issue is oversubscribed.

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The NSE IPO section also has a useful list of previously issued IPOs sorted by year. Thus you can take a look at the basic details of all the 94 IPOs of 2007 including the issue price and current stock price. This is a good way of evaluating how recent IPOs have fared in the markets.

Conclusion

The IPO process is quite complicated but by understanding the basic concepts and staying well-informed you can increase the odds of making a good investment.