Rohit Karna wants to buy shares on fundamentals and hold them for the long term. For the 55-year-old Patna businessman, who is new to stock investing, the challenge begins with the initial public offering’s (IPO) red herring prospectus (RHP). He finds this document, which runs into hundreds of pages, daunting. With the Jio Platforms IPO opening on October 21 and a busy IPO season ahead, his dilemma is shared by many.
The RHP offers a way to understand the business behind the shares. “A few hours spent reading it can offer more insight than a brokerage note,” says Manish Bhandari, founder, chief executive officer (CEO) & portfolio manager, Vallum Capital. That understanding can help investors hold on to the shares through weak quarters.
“Read the prospectus as a capital allocator deciding whether the business deserves your capital at the offered price,” says Karthik Balakrishnan, professor of accounting, Indian School of Business.
Start with the business
Begin with the business overview section: What does the company do, who buys from it, what gives it an edge and how much room does it have to grow?
Then see whether the financials support the story. Look for margins that hold as the company grows and sustained pricing power. “A competitive advantage should translate into returns on capital employed consistently above the cost of capital,” says Balakrishnan.
Debt outpacing revenue, or rising profits alongside flat or negative operating cash flow, warrants scrutiny. “Examine contingent liabilities for potential obligations that could affect the company’s financial health,” says Shoaib Zaman, director research, Peepal Bodhi Capital Services.
Know who is in charge
Examine management experience and remuneration. Have the promoters built successful businesses, or is this their first major venture?
Heavy share pledging can signal financial stress. “Past defaults, frequent management changes and excessive remuneration are red flags,” says Trivesh D, chief operating officer, Tradejini.
“Major pending court cases, fraud allegations or regulatory penalties warrant caution too,” adds Nilesh H. Sarda, Sebi-registered research analyst, Moneymint Consultancy.
Check for sudden auditor resignations or concerns about the accounts. “An auditor’s qualification deserves closer examination,” says Wahab Khan, Sebi-registered research analyst, Trading Sky.
Examine dealings with group companies
Look at the scale and terms of revenue, costs and financing involving the promoter group. Trivesh suggests comparing three years of transactions for sharp increases or unusual patterns. “Dealings with promoters or their relatives on unclear or unfair terms are red flags,” says Sarda.
Who gets the money
A fresh issue creates shares and funds the company’s debt repayment, expansion or other stated purposes. In an offer for sale (OFS), existing shareholders sell their holdings and receive the proceeds.
A large OFS deserves scrutiny, especially when promoters sell a substantial stake. “It raises questions about their confidence in the company’s future,” says Khan.
Next, look for specific capital expenditure or debt repayment plans. Vague allocations for general corporate purposes may signal unclear priorities and poor fund utilisation.
Check the valuation
The Basis for Issue Price section provides recent pre-IPO purchase prices and peer valuations. “Assess whether the peer comparisons are appropriate or selectively chosen, and whether the price is supported by fundamentals or driven by hype,” says Khan.
Look beyond the prospectus
Some answers lie elsewhere. Consult Ministry of Corporate Affairs (MCA) records for promoters’ directorships and associated companies, Sebi and stock exchange disclosures for regulatory action, and credit rating reports.
Don’t read the RHP cover to cover. Just focus on the key aspects described above. “Upload the RHP to an AI tool and ask questions about these key aspects,” says Zaman.
