You will understand IPO after reading this: NEPSE Investing Guide S01E03

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You must have heard people talking about applying for IPOs.

When I hadn’t started investing, I heard people talking about applying for IPOs of hydropower companies.

The words that they used sounded so foreign and strange.

This article is for you if you are like me when I was a beginner.

In this article, you will learn about Initial Public Offering (IPO), why companies issue IPOs, and why people apply for IPOs. You will also know what words like “kitta”, “share”, and “dividend” actually mean.

And trust me, all this isn’t as hard as you think.

What exactly is an IPO?

IPO stands for Initial Public Offering.

An IPO is a simple system that a company uses to raise money for its business. This happens when the founders of the company do not have enough funds to operate, grow, and scale their business.

They do this by offering an IPO to the general public. If a person applies for the IPO, he is called an investor. An investor is someone who puts funds in a business expecting the business to grow and be profitable so he can get back more money than he invested.

However, an investor does not only share the profits of the business; it also shares its risks and possible loss. If the company can’t grow as expected, it will be in a loss. Being in loss means that the investors will lose their money.

However, unless a company is completely bankrupt, investors will not lose all of their money. They will lose a part of their invested fund, which is determined by the stock market.

IPO Simplified

Let’s understand an IPO in even simpler words.

Let’s say you sell pencils on the streets. Each pencil costs five rupees for you. You sell them at ten rupees each, which means you will get a profit of five rupees in each pencil.

Your business is growing because everyone wants a pencil, and the profit margin is high: you double your money at each sale.

So, the logical decision would be to buy more and more pencils at five rupees and sell them at ten rupees.

However, you do not have money to buy more pencils, even if you know the business will be profitable for sure.

This is exactly what happens in business. They know they can be more profitable by expanding their business, but they can’t do it because of a lack of funds.

Growing your pencil business

Now, let’s say you request the people you meet to invest for you.

In return for putting the money, you promise to split their profits with them. In a sense, you are making an amazing offer to the public, hence called the Initial Public Offering.

Now, people will clearly see that your idea is profitable, and they will happily give their money for your business. Since everyone wants to grow their money, they will want to invest in your business based on their income and wealth level.

But how do you keep track of your investors?

The simplest and smartest way is to divide the fund into little units.

For example, let’s say you set the value of a unit at Rs. 100. Which means, for every Rs. 100 they invest in your idea, they own one unit of your company.

How many units will a rich guy investing Rs. 10,000 own?

100 units, of course.

This unit is called “kitta” in Nepali.

So, if you hear someone say they applied for 10 kitta in an IPO, just understand that they invested Rs. 1000, since each unit in an IPO is priced at Rs. 100 per unit.

The collection of units of investment is called shares. If you invest in a company, you are a shareholder.

Do I have to keep investing in the company at frequent intervals?

Not necessarily. The amount that you invested initially can be left to make money by itself in the business.

However, if you are confident, you can invest more in the future and own more shares.

How will I make money?

Let’s say, in your pencil-selling business, you get all the needed money from investors.

You then completely immerse yourself in doing business for a year.

After a year, you calculate your profits and find out that you can give your investors Rs. 30 rupees extra for every Rs. 100 they invested.

So, you call them all at your place, serve them tea, and hand them their extra money.

This is called an Annual General Meeting (AGM) in business terms. The amount that you distributed is called the dividend. In this case, you are giving your investors a 30% cash dividend.

This is what real companies have been doing for years.

But is it the only way to benefit from my investment?

There is also another way you can benefit from your shares.

Let’s say you bought the shares of a company by buying its IPO. However, as time goes on, you realize that the company will not be any more profitable. So, you will want to get rid of your shares.

And luckily, there will be other people who think the company will do great. They want the shares at all costs.

So, you two agree on a price such that you are profitable by selling it and the buyer believes he will be profitable because the price of the share will rise further in the future.

The stock market is the collection of buyers and sellers like you. In the stock market, there are thousands of buyers and thousands of sellers.

At any given time, all of them are buying and selling based on their own theory about where the company will go and whether it will be profitable.

Now that you have got a general idea, learn how to apply for an IPO by reading this article.

Wrapping Up

The stock market seems like a complex world, but it is just a bunch of greedy people meeting together to make money.

The financial terms sound fancy but they are all there for a logical reason.

I sincerely hope this article helped a complete beginner like you to understand the basics. These are questions that people don’t know the answer to, but hesitate to ask their friend because they fear sounding too naive or dumb.

Guess what, I am here to answer all your dumb, but innocent questions.