Since the Covid 19 2.0 wave has hit the country, there have been no new IPO launches, but a number of companies from across sectors have lined up for their IPO offerings. Now as we saw mind boggling subscription together with robust listing gains for IPOs in the recent past, you may be wary of some of the key concern areas:
Here we will discuss some of the key risks associated with IPO investments:
Before we begin for a laymen, let's make understanding of IPO clear:
IPO or initial public offer is an offer which the company makes for public issuance to raise funds from the market. While the investor may be lured to make early listing gains through the offer, the decision to invest needs to also factor all such risks:
Key Risks To Know when investing in IPOs
1. Shares may or may not be allotted in the IPO issuance:
After you apply, if you are eligible or fall within the reserved quota set out for your investor category type, you will be allotted the shares, else not. So, there is no guarantee of you being issued shares as part of the IPO.
Typically when there is over-subscription for an issue there are less chances of issuance of the shares.
Like for a stock, the right pricing at entry in the IPO is also crucial, and for this the valuation of the issue is highly crucial. As is the case now, there is a flurry of IPOs in the primary market when the liquidity is high and the indices are notching new highs and it is at this time that the offerings are made at high valuations. This does not augurs well for the retail investors as in such cases the issue under-performs the index in the long run.
Now after the stellar listing gains seen in the recent past for most offerings, this thing also has faded, now let's wait and watch how will the IPOs in pipeline will perform in respect of their listing as well as long term gains.
3. To make the complete analysis, there can be insufficient information available:
For some of the first-timers in the industry, it shall be hard to determine how would the company perform or how its peers have been doing. This is despite the financials being available in the Draft Red Herring Prospects (DRHP) with the SEBI. Say for instance:
4. Regulatory issues also need to be factored:
Say for instance in the last year concluded IPO offer of CAMS, these shares got listed on the NSE after 7 months of their entry into the capital market. This was because as at that time CAMS was being backed by NSE's subsidiary firm.
These IPOs may see sharp volatility in the first few days of their trade and also there is no limit in respect of when the trades in such stocks can be frozen.
Points to remember when investing in IPOs
1. Like for stocks, leveraging should not be taken on to for investing in IPOs i.e. an individual or an HNI should not borrow funds to invest in IPO.
2. Also, investors in IPO should not be unrealistic about their expectations of the IPO returns.
3. Retail investors should not get into illegal trades i.e. in the grey market.
4. When investing in IPOs it shall always be in the interest of investors to remain in the stock for a long run as with the company growth, your share in the company as shares will also see an growth.
5. For IPO investment, one needs a good economy, company and industry understanding to fairly narrow down on the IPO which shall be good for them.
6. Investors need not be lured by the newness of the company or industry instead should do adequate company and industry profiling together with its financial analysis as well as figure out the key risks as well as the areas that it may be exposed to across economic and business cycles.
7. If the investor invested for making listing gains, but an IPO disappointed on that front, it may be wise to rather exit that investment early.
8. Financials that need to be watched out include double digit return for Return on Equity as well as Return on capital employed. Also, earnings growth as well as its leverage position together with debt on the company's balance sheet need to be definitely given a heed before investing in the offer. Positive cash flow should be another factor that needs to be kept in mind.
The IPO investment is a high risk-high reward investment option and can be indeed avoided by retail investors and only after a sound understanding of the company's performance in the secondary market, its management as well as corporate governance the investor may get into the stock.