Investing in IPOs was a proven strategy for profit for veteran investors earlier. They waited for IPOs to be declared and jumped on it. During those times IPOs were not declared very often. Also, investors had a habit of keeping the shares allotted through IPOs, with them. They kept it with them because they acquired it at face value and knew that the price will multiply one day.
Many of them got huge returns from them. Many investors acquired more shares from rights and bonus issues. This is value investing. And later, when the true value unlocking of the shares happened, investors benefitted immensely.
But things changed with time and we observed that many IPOs are coming up, all of which are not truly worth investing. Unknowingly, just from old habits, some investors jumped for the IPOs grabbing them as good investment opportunities and invested a lot of money. But many of these companies were not good companies and after listing their prices go down a lot and stayed there. Nobody in the market would even touch them with a long stick because of the bad reputation they earned from the market.
Earlier, when the regulations were not so strong, some companies inflated balance sheets applied for IPOs and got approval. These companies used Dala Street to get rid of their burden. Ultimately the common retail investors lost their investment. But things are not the same today. The regulations are strict and SEBI keeps a close eye on companies applying for IPO. SEBI wants to create a safe investment environment.
Though we are seeing many IPOs coming up. Soon, the business environment accepts that the residual effect of Covid is almost over, we may see new IPOs coming up every month. Without looking at these IPOs as a great investment opportunity, every investor should gather all information available about the company. An investor should only invest in an IPO after understanding the health and future prospects of the company. Then the investor should also create a prior exit strategy in case the company doesn’t perform. In addition, the investor may create a quick exit strategy to earn a good profit from the investment.
In this article, we will discuss the IPO investment process and the pros and cons of investing in IPO for a beginner. We will keep our discussion limited to a beginner’s point of view. We assume here that a beginner has little knowledge of IPO investing and the merits and demerits of investing in IPO. This is a general guideline and not specific to any sectoral IPOs.
IPO investing
IPO is an initial public offer. When a new company wants to get listed in exchange and wants to go public, it takes the route of IPO. It applies to SEBI for approval. Once approved it floats share in the market through IPO. When IPO comes out, investors apply for it. After approval of shares, investors can trade these shares through the exchange where it is listed.
It is how an investor looks at it. IPO application for investors comes with a prospectus where all necessary information about the company is given. It allows the investor to know all possible details about the company. In the prospectus, a price band is given within which the IPO will fix one price and get listed in the exchange.
An investor has to apply for a minimum of one lot of shares. The lot size is given in the prospectus. Besides the lot size and price band, the opening and closing date of the IPO application are mentioned within which an applicant will apply for the IPO.
The bank or the broker engaged in the process will block the highest possible amount necessary to buy the applied lot. After the closing date, the listing date is also mentioned. On the listing date, the company’s share is visible in the exchange for trading.
Some companies also mention the Lock-Up period within which the stock can not be traded in exchange. In such cases, an investor can only trade the stock only after the Lock-Up period is over.
This is how an investor can apply for IPO and get a chance to acquire the shares of the new shares at face value or the minimum value fixed by the company.
Why should a beginner apply for IPO?
Assuming the investor is a beginner, we also assume that the investor hasn’t gone through the ups and downs of a market. Neither the investor experienced what happens to own investment when the market pass through bear phases. Whatever the experience is, a beginner in the stock market may think investing in IPO is an assured way to earn a good return on investment within a short time.
It is somewhat true, but the investment may go bad also unless the investor has a good exit policy. We have seen IPOs open in the negative and stay there for a long time. If the investor is new to the stock market and panicks seeing the negative price on the listing day, the investorwill end up losing money.
But if the investor studied the prospectus well and followed advice from well-known analysts and gained knowledge about the company, investing in IPOs may prove to be profitable for the investor. IPO is an easy way out for those who want to get profit in a short time. In an ideal situation, the investor applies for IPO, gets an allotment of the desired amount and gains 70-80% profit on the listing day. The investor bags the profit and sells all the allotted shares. Such instances are not rare and may happen again even in the next IPO. This is the most desired reason why should an investor opts for an IPO investment.
Let us discuss the advantages and disadvantages of investing in an IPO. This will help the reader to make a clear decision on investing in IPO.
Advantages of investing in IPO
A company issues IPO when it wants to go public. During IPO, the company issues share at face value without the addition of premium as in the case of other equity shares that are being traded in the market. Through IPO a company raises capital for expansion. In exchange, the company offers fair value to first-time applicants.
Therefore, the first advantage for the applicant is that the shares are available to the investor at the cheapest value and at fair value assuming the shares are not overpriced. Buying shares at a cheap rate is the most desired option for an investor.
Beginners should invest in IPO because there is a good chance to earn very good profitswithin a short time. We have seen many IPOs shoot very fast on the listing day. Some investors take advantage of this positive price gap and sell the entire allotted shares on the listing day if the price appreciation is more than 70-80%. It is another great advantage.
There is another advantage of investing in IPO. Many IPOs after listing, go high up and stay in a higher range due to high market demand. Imagine buying shares of Reliance Industries or Maruti, Eicher Motors etc. at their face value of Rs 10. The growth is unimaginable. A beginner can buy such shares at a fair price through IPO which is going to be a multi-bagger in future. Such an advantage is undeniable.
In addition, there are bonuses and rights issues given by the companies from time to time to shareholders. Thus, entering a growing stock at early stages bring immense advantages to the investor, even to a beginner.
But before starting, a beginner should also be aware of the disadvantages and risks of investing in an IPO. Let us discuss them.
IPO has some inherent risks. Nobody knows, whether a new company is going to perform or not. We have seen many IPOs never go back to their offer price after listing. Some trade at half the price of their offer prices long after listing. An investor can only get information about the company from the IPO prospectus. But it is not known how the market will react to the IPO, what other investors are saying about the company, and what is going to happen to the company in future. To avoid such uncertainties, an investor should plan some exit policies before investing in an IPO. The Grey Market also provides some information about the IPO but all information is not very reliable.
Let us now discuss some strategies. Beginners may adopt these strategies before investing in an IPO.
- A thorough research about the company is of prime importance. Collate all available information from the digital archive about the company and its financial health. Find the growth projection provided by the company. Do not go for IPO if you have even an iota of doubt.
- Should plan a proven exit plan before investing in IPO.
- After listing, an investor can use trading techniques using charts and technical analysis for taking the maximum profit out of the investment.
- A trader can map future support and resistance areas using Fibonacci Retracement methods. The traditional methods of finding support and resistance can also be applied.
- Know about the current trend. It is not advisable to invest in IPOs during bear phases.
- Wait for the Lock-Up period.
- Chose an IPO with a reputed brokerage firm.
Overall, we should say, IPOs are a good way of making money. A beginner investor should be aware of the risks before indulging in such investments.
- Should Beginner Investors Invest in IPOs? - May 27, 2023
Rohit Srivastava
I am Rohit Srivastava, Founder ofIndiaCharts, and I have more than 18 years of experience working at Sharekhan as a Fund manager. In Dec 2019, I Launched the Indiacharts Mentorship Program, the most comprehensive Learning experience for Serious and Passionate traders/investors wanting to get the A-Z of what I call ‘Complete Market Analysis’ in one place in a rigorous three-month experience.