IPO: Risks involved for Retail Investors

Markets seem to be improving. With some minor corrections happening on the way, medium and long term prospects of capital markets look bright. Taking a clue of this, several companies are planning to launch their much awaited, rather postponed IPOs soon. Around 20 companies will be raising about Rs.20,000 crores from the market in the next 6 months.


QIPs and High Networth Individuals are carrying huge surplus liquidity which will be diverted into such IPOs. However, if retail subscription numbers of recent IPOs is anything to go by, it has proven that retail investor seem to lack confidence. The 10 IPOs launched this year where undersubscribed by retail investors. For example, QIP subscription of the largest public IPO this year, NHPC was oversubscribed 29 times, but its retail portion was subscribed only 3.1 times.


While underwriters to the issue claim that the IPO is significantly underpriced, retails investors need to bear in mind that there are certain risks involved in investing at the time of an IPO which cannot be easily measured. Measuring risk profile of an IPO is difficult compared to the risk of a seasoned issue. Various models of IPO pricing behaviour also fail to explain the behaviour of IPO returns. They have their own risk profile which is different from the risk in investing in trading stocks.


Those times are long gone when small investors could blindly throw in money at IPOs and expect to gain big return in no time. While IPOs still are a good investment option, the focus has shifted to long term return potential. Here we will brief on some of the points which retail investors should know before they plan to invest their hard earned money into IPOs.


The most important point to be kept in mind is that several companies that launch their IPOs are new ventures and do not have a track record of profitability. This in itself is a big risk as there is no parameter against which an investor can compare the valuation. The prospectus issued by such companies at time of filling for an IPO may be overblown and overoptimistic about their future prospects. Nevertheless, it is advisable to read through the prospectus as it does indicate risk and opportunities related to the company. It is a healthy sign, if the Company plans to use the amount raised towards expansion or research and development. Contrary to this, if the amount will be used to pay off existing debts and liabilities, it is a bad sign as it indicates that the company is unable to generate cash to pay off its debt.


The other important point worth mentioning here is that these are the companies which are not extensively covered by other analyst to uncover hidden risks. Moreover, investment banks and brokerage firms that do provide information have their own interest in pushing their clients’ IPOs to ensure their own future business with them. Similarly, opinion of magazines and newspapers may be biased because of their vested interests.


It has always been observed that retail investors are last to enter when signs of economic direction becomes clear. With the picture of economic recovery getting clearer, confidence and appetite of retail investors will improve and they will be inclined to invest in IPOs.