IPOs inherently carry more risks than stocks that have been listed on the exchanges for some time.
Individual investors sold over 50 per cent of the shares (by value) allotted to them in initial public offerings (IPOs) within a week of listing, and 70 per cent within a year, according to a study by the Securities and Exchange Board of India.
The study compiled data from 144 IPOs listed between April 2021 and December 2023.
Lure of quick gains
Experts attribute the short-term approach adopted by retail investors to several factors. Most investors lack the necessary skills, nor do they dedicate the time and effort required to analyse each IPO thoroughly.
"Since investors lack conviction in the IPOs they invest in, they are unable to hold on to them for the long term," says Deepak Jasani, head of retail research, HDFC Securities.
He cites a couple more reasons for early exits. "Most IPOs are offered at high valuations. After listing, many fall in value, so investors exit early to avoid possible losses," he says.
In bullish market conditions, a large percentage of IPOs provide listing gains.
"Most retail investors do not understand the fundamentals of the company nor read the red herring prospectus. They simply bet on the likelihood of listing gains in a bullish market," says Ankur Kapur, head of investment, Plutus Capital.
Many investors also rotate their funds into other IPOs.
"The reduced timeline for IPO listings allows investors to quickly assess their positions and reinvest their capital in new opportunities," says Sarvjeet Singh Virk, co-founder and managing director, Shoonya by Finvasia.
Short-term view enhances risk
Short-term bets on IPOs carry several risks. "There is no guarantee every IPO will open at a premium. Sentiment and narrative can turn at any point and an IPO can list at a discount, causing losses," says Kapur.
Short-term bets also carry an opportunity cost. "If the stock becomes a multi-bagger in a few years, investors miss out on its appreciation over the long term," says Jasani.
He further points out that selling a stock in less than a year results in a higher 20 per cent tax on short-term capital gains.
Enter with adequate horizon
Seasoned and confident investors should hold their investments in IPOs for the long term, according to Virk.
Kapur suggests that as with other equity investments, one should invest in an IPO with a minimum three-year horizon, though five years or more is ideal. "Only with such a horizon can you expect meaningful returns," he says.
IPOs: Riskier than already-listed stocks
IPOs inherently carry more risks than stocks that have been listed on the exchanges for some time.
"These are new and untested companies. For stocks that have been listed for some time, historical data is available on management performance and corporate governance," says Jasani.
"Analysts also have an insight into whether management meets its earnings guidance. That history is not available for the management of IPOs," adds Jasani.
Companies typically launch IPOs when their recent performance appears strong.
"If the company is facing difficulties, it will not disclose them. Moreover, investors may enter at the peak of the company's business cycle, after which things may go downhill," says Jasani.
Unlike established companies, IPOs lack a comprehensive track record of financial performance. Investors have to rely on the limited data provided in the prospectus.
"This makes it challenging to assess the company's profitability, stability, and growth potential," says Virk.
Another challenge is the information asymmetry in IPO investing. Promoters and early institutional investors sell and exit their holdings, partially or fully. Retail investors buy from them.
"The seller is better informed and stronger, while the buyer is uninformed and weaker," says Kapur.
IPOs are usually offered at high valuations, allowing promoters to maximise their returns. These high valuations reduce the likelihood of retail investors making profits, even over the long term.
Conduct due diligence
Retail investors should carefully assess why the company is raising funds through an IPO. If the funds are intended for business expansion, research and development, marketing, or paying off debts, the purpose can be considered reasonable.
"An IPO that primarily provides liquidity to early investors, such as through an offer for sale (OFS), could be a red flag," says Virk.
Investors should thoroughly review the prospectus to understand how the company generates revenue and profits. They should evaluate its market position, competitive advantages, and growth potential.
"Identifying key competitors and assessing the company's market share, strengths and weaknesses relative to them is crucial," says Virk.
Wait for the right valuation
Once a company has been listed for three months to one year, its reality begins to emerge.
"Even if it is a high-quality business, there is a good chance you could buy the stock at a lower valuation six to 12 months later, once the euphoria around its listing has faded," says Kapur.
"A market downturn may also provide a better entry price."
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Feature Presentation: Ashish Narsale/Rediff.com
