The book value is defined as the difference between total assets and liabilities. In a more crude way it is also defined as the amount that will be left back after paying all liabilities in case of a closure. The P/B of an IPO is calculated as Market value divided by the Book value. It gives an idea on what value the market places on the stock based on its books.
This two part article tries to give you a simplified idea of how to analyse IPOs using technical and fundamental analysis.
There have been raging discussions during the past three years both when the Indian IPO market was booming and when it was crashing. Should be invest in IPOs or rather buy the stock when it comes to the secondary market. The argument is a long drawn one with varying answers during booms times and during bust times. This article will try to give us some tools and ratios which could help us decide on whether to invest in an IPO or no at any time!
Analysis based on Market value (Market cap)
Market value in the case of an IPO can be defined as the number of shares available for subscription multiplied by the price per share plus the price per share multiplied by outstanding shares if any. In the case of analysis when there is a price band available, it’s advisable to do the analysis based on the lowest price.
Check 1: Price to sales (P/S)
This number is derived by dividing the market value by the value of annualized sales. It can also be derived by dividing the price of a share by the sales per share. It is basically an indication of the amount the company is trying to garner from the market vis-à-vis its current business.
A rule of thumb for the P/S ratio when deciding on IPO investment is that lower the P/s ratio the better it is as an investment. A word of caution is that this should not be the only parameter before deciding.
Check 2: Price to Earnings (Loss) P/E:
This number is derived by dividing the market value by the annualized profits (loss) for the company. It is an indicator of the number of multiples that the market is ready to pay for the stock over its current profit levels. If the profits is 2500 crores and number of equity shares is 1000 then the P/E is 2.5. Meaning, the market is ready to pay 2.5 time the profit per share to buy the stock.
Thumb Rule for P/E w.r.t IPOs: The lower the P/E the better it is for the investor. In simple terms a lower P/E means you are getting to buy something that has the ability to reap high benefits at a very cheap price. The irony is that during boom times uniformed investors get carried away by high P/E multiples.
Check 3: Price to Book value: (P/B)
The book value is defined as the difference between total assets and liabilities. In a more crude way it is also defined as the amount that will be left back after paying all liabilities in case of a closure. The P/B of an IPO is calculated as Market value divided by the Book value. It gives an idea on what value the market places on the stock based on its books.
Thumb rule: Lower P/B the better. It would be advisable for a potential IPO investor to look for IPOs with low P/B. Some of these stocks are called value stocks. Long term investors buy such companies and hold on to them till they slowly but steadily grow their business till a day when the share prices might shoot up phenomenally and then exit with huge profits.
Check 4: Price to tangible book value (PTBV)
This number is derived by dividing the market value by the tangible book value. The Tangible book value (TBV) is equal to the book value of the company minus the intangible assets. Intangible assets are those that cannot be seen or felt. Examples include IP rights, Goodwill patents etc. Similar to P/B it can also be crudely seen as the amount an investor would get if the company ceases to exist and all its assets have to be sold. The reason it is seen separately is that most intangible assets would be very difficult to sell in case of closure.
Thumb rule: Lower the PBTV the better. A PBTV of 0-1.0 means the company is trading at or below the worth of its own tangible assets. Once the mark crosses one, the risk for the investor too is proportionally higher. In case of certain companies the PBTV could be negative too.
Check 5: Gross margin percentage
The gross margin percentage is derived by dividing the gross margin of the company (the margin before accounting for taxes, depreciation, expenses etc) by the total value of sales. This gives an idea of what is the percentage of margins for any value of sales.
Thumb rule: Higher the gross margin the better. This in simple terms indicates that the company’s product of service has a good margin of income. The higher the gross margin the better would the actual profit be. For certain industries where costs are very high the gross margin% would be low. In such cases we need to analyse if its higher than for other competitors in the same domain of business.
Check 6: Profit margin%
This number is derived by dividing the Profits by total value of sales. Again as in the case of gross margin percentage higher the profit margin% the better it would be to invest in the IPO of that company.
A word of caution though. The Gross profit margin% and the Profit margin% should be analysed for at least 3-4 years to check for consistency. Some companies might show higher margins due to one off reasons which might not hold true after the IPO.
All the above calculation needs to be taken into consideration along with the analysis of the company’s management, its business model, the sustainability of its product/service and other such fundamental parameters.