Big IPOs can be a trap so weigh the pros and cons carefully before investing

Investment

oi-Monika Nihalani

By Monika Nihalani

Published: Monday, July 18, 2011, 12:54 [IST]

All that glitters is not always gold! Investors usually get lured when big daddys' comes up with Initial Public Offer (IPO). They think that if the company has name, fame and strong background so their IPO will be a hit and they can make big money. But don't get trapped easily by investing in IPOs before doing thorough research, they can be a over-priced and your investments can turn into losses.

There are few points to consider before investing in Big IPOs:

Red-Herring Prospectus:
Go through the red-herring prospectus carefully before making an investment decision, because that will be only source available to you to have an analysis as IPOs lack in providing historical information.

Bull Rallies:
Most of the large corporates raise money through IPO when markets are in bull run so as to get more valuation of their shares. Reliance Power is the best example to quote, it was launched when markets were bullish and soon after its launch, it lost ground. It hurt a lot of retail investors including several of whom had opened fresh Demat account for the IPO. It was the time when students, housewives, barbers, paanwalas and everyone possible had become the fund managers overnight, they invested in and lost money.

Markets usually follow a correction after any big IPO has been launched.

Over-pricing of the share:
Big daddy's usually comes up with an IPO when market valuation of their companies is good so as to seek more money from the market resulting in over-pricing of their shares. Investors often love to be the part of growth story of the large corporates, even if those companies are charging premium they wouldn't hesitate to invest in their IPOs.

The Intelligent Investor, Benjamin Graham cautioned investors that, "No matter how many people want to buy a stock, you should buy only if the stock is trading at cheap levels".

Lock-up agreement:
When a company goes public, insiders, company officials and employees are asked by underwriters to sign a lock-up agreement. Lock-up agreements is usually between 90-180 days. Its a period when insiders, company officials or people with majority stake in the company are prohibited to sell any of their shares. And, once the lock-up period ends, they are free to sell their shares in the market.

So after lock-up period, there is a huge sell-off by insiders which may turn fall in share price further.

Bottom Line:
Before investing in any big IPO, look for the useful information about the company as what does the company do, their management team, purpose for raising money and where the company aims to invest, expected profitability time frame as when the company will start making money. All these information will help you out to make an effective decision.

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