7 Strong Reasons To Avoid Investing In IPOs

Thinking of investing in IPOs (i.e. Initial Public Offering) shares? The market always has buzz when there is a big company about to launch its first-ever IPO. There would be many business news channels talking about it and many finance new papers publishing articles and sharing views about those companies. But are you able to answer the following questions before investing in IPO share?

  • How much do you know about the IPO and IPO share allotment process?
  • Do you have genuine information about the company and its right valuation?
  • Are you sure about the valuation of the IPO issue price?
  • Were your previous experiences with IPO shares were good?
  • Have you done your analysis on the company you are interested in applying for IPO?
7 Strong Reasons To Avoid Investing In IPOs

Perhaps, you already know about IPOs but in case if you don’t have clear visibility, this post will be very helpful for you to decide whether to invest in IPOs or Not? Before we jump into the reasons for not investing in IPOs, let’s go through IPO basics.

What Is An Initial Public Offering (IPO)?

Initial Public Offering can be considered as a process of transforming a privately held company to a public company by offering the company’s share to the institutional and retails/individual investors.

The valuation of the company will be underwritten and decided by one or more investment banks. It could be listed on one or more than one stock exchange.

Once the company decides to go public, they evaluate the company’s valuation and offer the IPO price in public. These offer prices are usually very high in most of the cases and the investors will have to place their bids on these prices if they want to apply for it.

Why Does A Company Go For IPO?

If the company has decided to go public and share ownership with many investors, definitely they will have strong reasons for it. Following are the common reasons (not limited to), why companies go public:

  • To raise funds to expand their businesses locally and globally.
  • To reduce the overall debt.
  • Spread the risk with a large group of stakeholders.
  • Arrange interest-free funds to run their businesses.
  • Acquire other companies
  • Probably the founders or early investors are looking for an exit, etc.

Issuing IPO could be very difficult for the company owners or early investors because thing becomes different once the company goes public. Owners will not have 100% control over all the decisions and business plans and they need approvals from shareholders for major decisions.

Becoming a partner in a company sounds interesting and it becomes more interesting when you get the chance to be one of the first ones. However, I see many downsides of investing in IPOs, and following are the reasons.

7 Reasons To Not To Invest In IPOs

The following are the 7 strong reasons to avoid investment in IPOs but not limited to.

1. High Valuation or Overvalued

When the companies decide to go public or issue IPO, they usually hire an investment banker to analyze the company’s valuation. Once the company’s valuation is decided, it is then divided by the no of shares to be issued. This gives the IPO offer price.

IPO prices are announced in range e.g. INR 200-230 and investors can bid as per their view. But there is almost no visibility for retail investors to confirm if the valuation at which the IPO price band has decided is justifying the actual valuation. Most of the time the company valuation shown is very high.

2. IPOs Don’t Perform In A Long Run

You may hear a lot of buzz when any company is about to issue the IPO and if the company is well known already then it might show a 10-20% jump in price on the listing date. However, with most of the IPOs, there is a different story.

Since most of the IPOs are overvalued therefore the reversal trend may start early once the company starts publishing its quarterly and yearly performance reports. Following is the chart (credit – google finance) of a famous company and a leader in the reinsurance business i.e. “General Insurance Corporation of India“.

General Insurance Corporation Share Chart

Even though the company had good fundamentals and strong management but still it is showing downtrends. The company valuation was high at the time of the IPO launch.

3. Your IPO Order Might Not Get Fulfilled

IPO comes with a price band and lot size. Investors have to place their bid with desired quantities/lot within the given date and time. Once IPO is subscribed by the investors, the allotment of the IPO shares starts which is a lottery system.

If a company is involved in good business and performing well also listed on a fair price, the IPO will be oversubscribed and chances of getting your IPO order execution becomes very less. If you are lucky then you might end up with at least one or two lot of the shares.

In a nutshell, if you have applied for a good company’s IPO, your chances of getting IPO allotted very less.

4. You Might Get Stuck With Bad Company Stock

Most of the time when you apply for in any company’s IPO, you try to apply for the maximum quantities possible hoping to get at least one lot allotted.

As I explained earlier, the chances of getting IPO allotted are very less if you have applied for a good company’s IPO. However, if you have applied for a not so good company’s IPO, your full order might get executed and you might end up with a lot of shares in bad companies.

Such IPOs tend to open in negative on listing day and continue the trend for a few weeks before taking showing an upward movement.

5. Your Money Gets Blocked

When you apply for an IPO, your money equivalent to the worth of the IPO share gets blocked until the allotment happens. It takes 1 or 2 days to get the money in the linked bank even after the IPO allotment date.

If you are lucky and got IPO shares allotted then it is understood but what if you applied for IPO shares but your order didn’t get fulfilled? Your money might be blocked for more than a month.

This might not be a big issue for many investors but you should take this as well into consideration before applying for any company’s IPO.

6. No Visibility On The Company’s Conditions

Most of the investors hardly know real facts about the company. We as retail investors have minimum access to the company’s information and we tend to react on what is being told on news channels or published on the internet.

Sometimes, the IPO of a company will create hype in the market and it will be promoted like never before. Most of the investors will think of it as a lifetime opportunity to grab the overvalued IPO. It might not be the case for all company’s IPO but we never know unless we see some real financial numbers.

Applying for the company’s IPO without knowing the real issues in the company could be dangerous in the long run. Share might show some rally but when the reality comes out, it will start showing its real worth.

7. IPOs Could Be Very Risky Investment

As I explained in this article that, the retail investors have very little visibility on the company’s financial condition. Even though the company explains the reason behind Initial Public Offering but we hardly know the real reasons behind it.

The retail investors can’t evaluate the justifiable net worth of a company or IPO price band. Without knowing the complete information, investing in any instruments could be very dangerous in the future.

An important key to investing is to remember that stocks are not lottery tickets – Peter Lynch

These were my top 7 reasons to stay away from the investing in company’s initial public offering (IPO). You may come across many other reasons to avoid investing in any IPO, once you start investing in it.

I am not trying to say that, all the IPOs are bad and should be avoided. There have been IPOs of the good companies that have made fortune for the investors. However, one needs to invest some time in researching and analyzing companies to find the best IPOs. Moreover, I have some working tips to identify good IPOs from the pool.

5 Useful Tips For Investing In IPOs

The following are important tips that could help you to find good IPOs for investment.

  1. Always try to learn about the company as much as possible. You can research on the internet, visit the company’s website, sneak into the public forums, and try to explore the company’s reputation in the market.
  2. Try to select a company that is well known to the market and has a good presence backed by strong management.
  3. Be alert if you hear more than the expected promotion of an IPO. This could be a sign of overvalued and doubtful IPOs.
  4. Always go through the company’s reason behind the IPO launch and its business plan after listing the company. This will give you some confidence.
  5. Go through the company’s financial statement of previous years if you can find it on their official website.

These were my 5 useful tips for investing in IPOs however, you should find as many ways as possible to analyze the company. After-all you are investing money and you want to get more out of your investment. Protecting money from losing in the market should be your number one priority.

Rule no 1: Never Lose Money and Rule No 2: Don’t Forget Rule No 1 – Warren Buffet

Conclusion

IPO issue is a process of transforming privately held companies to public company. Companie issue IPO to get the interest free fund from the public and invest in the company’s growth and expansion strategies.

It could be seen as an exit strategy for founders and early investors by booking good profits.

Most of the IPOs offer overvalues price band and they have given poor returns in the long run.

One can go for investment in IPOs after proper research and analysis of the company.

Now you know the 7 strong reasons to stay away from the IPO investment. Also, if you want to invest then you know the 5 useful tips to identify good company’s IPO.

Read Also..

Frequently Asked Questions

  1. Can NRIs Invest In a IPO?

    Yes! NRIs can apply for the Indian Company’s IPO by using their NRO account. They need to have a Demat account to manage shares once allotted. They can apply from their online trading account directly.

  2. Does the stock price go up on the IPO listing day?

    There no guarantee that the stock price will go up on the listing day. If the IPO was overvalued and faces less investor interest in the market then it might open in negative also.

  3. Is buying stock at every IPO a profitable strategy?

    No! It is not recommended to buy stocks at every IPO. Most of the IPOs have given poor returns in the long run and if you failed to identify the quantity IPO then you might lose money very quickly.

  4. Will I get my money back if shares are not allotted?

    Yes! You will get your money if the shares are not allotted to you. However, your money will be blocked until the shares are allotted to every bidder.

  5. How can you find the day a stock will start trading when it IPO’s?

    Every IPO announces the listing day before or after the shares allocation. The stock will be listed on the same date and anyone can buy or sell the shares of that company.

I hope you found this article useful and it helps in your investment strategy. The information on this article is only for the education purpose and you should consult with your financial advisor for any investment in the market.

If you liked the article, then please consider sharing it with your friends and family. You can also subscribe to the Investopus mailing list. Don’t worry! we are against the spamming.

Do let me know your experience with IPO investing? Did you able to achieve multi-fold returns? or booked heavy losses?

Leave a Reply

Your email address will not be published. Required fields are marked *