How to Evaluate IPO Financials Before Applying

Why Financial Analysis Matters for IPOs

Unlike a listed stock where you can observe years of price history and market reactions to earnings, an IPO forces you to evaluate a company based purely on its financial disclosures. The company chooses the timing of its IPO — typically when conditions are favorable and its own financials look strongest. This creates an inherent information asymmetry that makes financial diligence critical.

The good news: the DRHP/RHP contains three years of audited financials. If you know what to look for, you can form a well-grounded opinion in 30–45 minutes.

Step 1: Revenue Trend — Growth Rate and Quality

Start with the top line. Extract revenue for the past three financial years and calculate year-over-year growth rates.

• Consistent growth (15–30%+ per year): Positive signal. Shows the business is scaling.
• Revenue spike only in year 3 (pre-IPO year): Caution — could be channel stuffing or aggressive recognition to boost the IPO story.
• Revenue decline or stagnation: Requires a very compelling explanation. Is it an industry cycle? A one-time event? Or structural decline?

Also check revenue quality: Is revenue diversified across customers, geographies, and products? Or is it concentrated in one or two sources that could disappear?

Step 2: Profitability — EBITDA and PAT Margins

Revenue growth means little without improving margins. Track:

• Gross margin: Revenue minus direct cost of goods/services. Measures pricing power and operational efficiency.
• EBITDA margin: Earnings before interest, taxes, depreciation, and amortization as a percentage of revenue. Reflects operational profitability excluding capital structure.
• PAT (net profit) margin: Bottom-line profitability after all deductions.

What to look for:

• Are margins expanding over three years? That is the ideal scenario — a scaling business with operating leverage.
• Are margins contracting despite revenue growth? This signals competitive pressure, rising input costs, or poor cost management.
• Many new-age tech companies are loss-making — evaluate their path to profitability using unit economics (CAC, LTV, contribution margin per order/user).

Step 3: Cash Flow Analysis

This is where many retail investors stop reading, and where the most important insights hide. A company can show accounting profits while hemorrhaging cash.

The three cash flow statements to review:

• Operating Cash Flow (OCF): Cash generated from the core business. This should be positive and growing for a healthy company. If OCF is consistently negative despite profits, look for aggressive revenue recognition or mounting receivables.
• Investing Cash Flow: Money spent on capex, acquisitions, or investments. Negative is normal for growing companies (they invest in assets). Excessive capex relative to revenue can be a concern.
• Financing Cash Flow: Equity raises, debt taken or repaid, dividends. Consistent large borrowings while OCF is negative is a red flag.

Key ratio: OCF / Net Profit. If this ratio is consistently below 0.5 (meaning operating cash flow is less than half the reported profit), investigate why. It often points to aggressive accounting.

Step 4: Balance Sheet — Debt and Working Capital

Review the balance sheet for two key areas:

Debt levels:

• Total debt to EBITDA: A ratio above 4x suggests the company would take 4+ years of operating profit to repay debt. Acceptable levels vary by sector (infrastructure companies can carry more debt than tech).
• Is the IPO being used to repay debt? Not inherently bad, but check if the debt was taken for productive purposes.
• Watch for contingent liabilities (off-balance-sheet obligations that could become real debt).

Working capital:

• Receivable days: How long does the company wait to collect payment? Increasing receivable days can signal collection issues.
• Inventory days: How long does inventory sit before being sold? High and increasing days could mean demand is falling.
• Payable days: How quickly does the company pay suppliers? Extending payable days is a way to manage cash but can damage supplier relationships.

Step 5: Return Ratios — RoE and RoCE

• Return on Equity (RoE): Net profit ÷ shareholders' equity. Measures how efficiently the company uses shareholder capital. A sustainable RoE above 15% is generally considered strong in India.
• Return on Capital Employed (RoCE): EBIT ÷ capital employed (equity + debt). Measures returns on all capital. Compare to the company's cost of capital and to sector peers.

Both ratios should be checked over all three years, not just the most recent. Declining RoE and RoCE despite rising revenue is a warning sign.

Step 6: Valuation Comparison

Once you have the financial picture, assess whether the IPO price is fair:

• Calculate P/E at the issue price using the most recent year's EPS (earnings per share).
• Find 2–3 listed peers in the same sector and compare their P/E multiples.
• Check if the IPO valuation premium is justified by superior growth, margins, or market position.
• The DRHP itself provides a peer comparison table — use it as a starting point but do your own verification, as companies often cherry-pick favorable comparators.

Quick Screening Checklist

• Revenue CAGR (3 years) > 15%? ✓
• EBITDA margin stable or expanding? ✓
• Operating cash flow positive in last 2 of 3 years? ✓
• Debt-to-EBITDA below 3x? ✓
• No suspicious revenue spike only in pre-IPO year? ✓
• RoE above 12%? ✓
• IPO P/E not more than 50% above sector peer P/E? ✓

An IPO that passes all 7 checks deserves serious consideration. One that fails 3 or more requires extraordinary justification.