Understanding IPOs: Key Considerations for Investors
Initial Public Offerings (IPOs) have witnessed significant fluctuations in interest over the years. From a surge from 2004 to 2008, a brief resurgence in 2015, to a renewed wave of enthusiasm since last year, it’s essential for potential investors to approach IPOs with caution. Many individuals dive into IPO investments for misguided reasons. To safeguard your investments, here are three critical questions to reflect on before subscribing to an IPO.
1. Why Do You Want to Subscribe to the IPO?
Investors often make the mistake of wanting to invest in an IPO simply because they admire the company’s products or services. While being a consumer of a brand can enhance your understanding of the business, it should not serve as the sole reason for investment. The sustainability of a company’s growth cannot be determined solely by personal consumption.
Avoid the herd mentality where you think that if everyone else is investing, it must be a wise choice. This was evident during the dot-com bubble of 1999-2000, when investors poured money into tech companies without adequate research, resulting in significant losses as many of these firms vanished or were delisted. Similar patterns occurred in the real estate and infrastructure sectors during the financial crisis of 2007-2008. Investors should critically evaluate each opportunity rather than jump into investments solely based on popularity.
2. What Is Your Investment Based On?
Before investing, evaluate the company’s fundamentals. Ask yourself the following questions:
- What is the company’s business model?
- What are its growth prospects?
- How stable are its finances and cash flow?
- What is the background of the company’s management?
- Is the IPO price justified based on your analysis?
- What is the primary purpose for raising funds – expansion, debt reduction, acquisitions, or something else?
Keep in mind that companies aim to maximize value when offering shares to the public. Most IPOs are launched during bullish market conditions where demand is high, consequently leading to potentially inflated valuations. Therefore, not all IPOs can be assumed to be at an attractive price point.
3. Are You Buying Just to Sell?
Many investors approach IPOs with a strategy to sell quickly once the shares are listed. However, this is a risky tactic, as indicated by a recent study by the Securities and Exchange Board of India (SEBI), which revealed that non-institutional investors—those bidding more than Rs 2 lakh—constitute the majority of sell-offs on listing days. These investors often depend on external funds for their bids and frequently sell their shares shortly after listing.
Statistically, around 54% of IPO shares allotted are sold within the first week of trading. It’s also noteworthy that a substantial number of IPOs do not provide returns post-listing. For long-term success, consider holding onto your investments rather than cashing out immediately. By paying the right price, you enhance your chances of profitability.
Conclusion
Investing in IPOs can be an exciting opportunity, yet it requires careful analysis and strategic thinking. By asking the right questions and evaluating your investment motives, you can position yourself to make informed decisions that align with your financial goals.
