Mistakes To Avoid While Investing In IPOs

The IPO market in India has been booming for the last few years, especially after the pandemic. The entry of a large number of retail investors and a sustained market rally has further given these companies, including new age tech – driven businesses a reason to test Indian equity markets. Investor frenzy has been evident in high market participation of a wide variety of companies, offering a range of products and services and the relative success that they have seen. However, this also comes with its own set of problems, specifically for the retail investors.  

Whether you are convinced about a company’s future prospects, or just want to make a quick profit, IPO investing is still a bet you should rather explore after taking into consideration some important factors.

Top mistakes to avoid while investing in IPOs

1. Not knowing the business

Investors need to understand that even if they are putting money in ‘just an IPO’, the basics of investing remain the same – knowing what they are getting into, is of paramount importance. IPO investing is, indeed, similar to buying stocks in a business you know really well. Thus, before finalizing the IPO investment decision, try to gather as much information as you can from multiple sources, like websites, business magazines, past employees, management interviews / commentary etc.     

Try to understand the business model, the clients and financial health of the company, its liabilities, debt situation and future growth prospects. The very essence of a business is based on its ability to make profits. So, no matter how hard it markets itself, you should be able to analyze its profit making ability clearly.  

2. Skipping basic research

Keep in mind, reviews can have a certain bias of the person or institution sharing it. So, do not go purely by what the broker, demat service provider or advisor tells you. First of all, check the company’s reason and motive for the IPO and how it plans to utilize the IPO proceeds. Make it a point to check for other critical parameters like past performance, revenue stream, management commentary, risks, disclosures etc. It is essential to note that in this digital age, every move that the company or management makes, leaves a footprint. 

Conducting this very basic, but effective research is one of the efficient ways to evaluate potential IPO investment ideas.

3. Underestimating valuations

It is a good idea to look at this quantitative measure for proper IPO evaluation. Investors should look closely at the company’s cash flows, financial ratios, profitability, debt obligations and performance of competitors in the same business category. Though, comparing the valuation metrics with competition does not always make sense, especially if it is a tech-based company or an entirely new business segment. 

In many instances, the valuations given to a particular company would seem to be unjustified. Investment bankers have their own ways and reasons for evaluation and assigning a certain price. If an issue is hugely mispriced, it will open at a discount. It might then take a long time to reach even the listing price.

Thus, it will be to your advantage to correctly assess the worth of the business you are planning to associate with.

4. Going by bull market hype

In a bullish market, chances of an IPO getting a good response increase and so do the chances of it getting listed at a premium. Similarly, in an overall declining market, the chances of both market participation and listing gains decrease. Thus, placement and timing of the IPO plays an important role. Some promoters might just try to exploit opportunities by pushing their IPOs in bull markets and thus investors need to look out for such companies carefully. Identifying good companies with long term vision and a clearly defined business model would definitely help in choosing the right business.

5. Investing without a plan

It will be a good idea to pre- decide your action after listing. If you are sure about the company’s future prospects, it will make sense to continue with your investment. On the other hand, if you are just trying to make a quick profit, think twice. In this case you are just gambling and it can go in either direction, so you should be ready for the consequences. If it opens at a discount, you will either be stuck for an unpredictable timeframe, or will have to sell at a loss. 

Also, with many IPOs getting oversubscribed multiple times, chances of allotment are really low. In any case, a small allotment of a few shares would not yield very high returns in absolute terms.

6. Ignoring the fine print

There are many guidelines and regulations, which a company should abide by, before listing. Some of the vital details related to the business, promoters, sources of funds, dividends, major partners, etc is available in the Red Herring Prospectus. 

This document can be critical to your decision of investing in its IPO. Even if you do not want to read it page by page, it will be a good idea to go through the key highlights which will impact your future course of action.

The prospectus can be downloaded from the company’s portal and is also available on SEBI’s website.  

Conclusion

By avoiding the above-mentioned mistakes, investors can be better placed in taking well-informed and thought-through investment decisions. It is good to keep in mind that in investing, FOMO (Fear of missing out) should not be the driving force for exploring great opportunities. Just because your friend or colleague made easy money in some IPO does not mean that you will also see a great listing for the business you have invested in. Thus, exercising caution will save you from future disappointment.

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