Introduction:
Initial Public Offering, hereinafter referred to as IPO, is a process where a private company sells its shares to the public and gets listed on the stock market. It is a popular and exciting investment option, but it also carries some risks. Interest in investing in IPOs is growing daily, and the number of IPOs is also growing with it. As of 2024, 268 IPOs were listed, 90 of which were in the mainline and the remaining 178 were SME (Small and Medium Enterprises) IPOs, raising a total of Rs. 1.67 lakh crore from the public. In this blog, we will explain in detail what an IPO is and the benefits and risks of an IPO investment.
Table of Contents
What is an IPO?
IPO is a process where a private company lists its shares in the stock market by sharing its ownership with the public. Its main purpose is to raise money from the public so that the company can achieve its growth, expansion, or debt repayment goals. When a company makes its shares available to the public for the first time, this process is called an IPO. These shares start trading on exchanges like NSE (National Stock Exchange) and BSE (Bombay Stock Exchange). IPO is a fundraising tool that gives investors a unique opportunity to be a part of the early growth stage of a company.
Steps to Invest in IPOs:
Investing in IPOs is a very simple process, but it is important to follow a procedure:
Opening a Demat Account:
To invest in an IPO, firstly, you need to open a demat account. This account can be opened with any Registered Depository Participant (DP), such as a bank or brokerage firm.
Read the Details:
The Red Herring Prospectus (RHP) contains all information regarding the company’s finances, risks, and offerings. A company files the RHP with the Securities and Exchange Board of India (SEBI) before its IPO. Before investing in an IPO, it is important to read the RHP carefully to assess the investment opportunity. Along with reading the RHP, it is also important to perform peer comparison, i.e., compare the IPO company’s financials with those of other companies in a similar sector.
File IPO Application:
After reading the RHP and evaluating the risk involved, you can apply for the IPO. ASBA (Application Supported by Blocked Amount) is used to apply for IPO. ASBA is a facility that blocks the required amount in your bank account until the IPO allotment is finalized.
Wait for the Allotment:
After the IPO application process is completed, usually within 1 to 2 weeks, the allotment process is completed, where it is decided who will get the shares. If you get an allotment, the shares are credited to your demat account.
Trading on the Listing Day:
Once the shares from the IPO are officially listed on the NSE, BSE, or both, investors have the opportunity to trade these shares in the vibrant stock market. On the listing day, the share price often exhibits volatility, swaying up or down in response to the dynamic interplay of demand and supply. Factors such as investor sentiment, market trends, and overall economic conditions can all contribute to whether the stock price rises or falls, creating a dynamic environment for traders and investors alike.
Benefits of IPO Investment:
There are many benefits of investing in IPOs, here we will discuss those benefits in detail:
Potential for High Return Within a Small Period:
Investing in IPOs is a unique opportunity for investors where they can get significant listing gains. If the company’s business model is strong and there is high demand, the share price can increase significantly on the day of listing. For example, IPOs like Bajaj Housing Finance and Premier Energies Ltd. have given impressive returns to investors in the initial days in 2024.
Early Entry into Promising Companies:
A major benefit of IPO investment is that you can be a part of fast-growing and promising companies when they are in their early growth stages. This allows you to multiply your investment with their growth.
Ownership in Companies:
When you invest in an IPO, you gain partial ownership by getting shares of that company. Ownership means that you get a share of the company’s profits and future growth, either through dividends or through the appreciation of the share price.
Transparency:
During the IPO process, the company has to disclose financial details and objectives in its RHP. This disclosure gives you a clear idea about the company’s business model, profitability, and future plans. This transparency helps you make informed investment decisions.
Opportunity for Long Term Wealth Creation:
Another major benefit of IPO investment is long-term wealth creation. If you hold shares of fundamentally and financially strong companies, you will get stable returns as their business and profits grow. Investors who have invested in IPOs of companies like Reliance, Infosys, and Wipro have achieved extraordinary returns in the long run.
Portfolio Diversification:
By investing in IPOs, you can add diversification to your portfolio. Shares of new and innovative companies add a new dimension to your portfolio, which helps reduce risk.
Become a Part of Economic Growth:
When you invest in an IPO, you are not only investing in a company but also indirectly contributing to the growth of the economy. Your investment helps in the expansion of the company and job creation. This in turn increases the GDP of the country.
Reservation for Retail Investors:
In many IPOs, a certain portion is reserved for retail investors. This ensures that retail investors also get a better chance of getting allotted shares.
Risks Involved in IPO Investment:
Investing in an IPO is an exciting opportunity but it also carries some significant risks. Here we understand the major risks of IPO investment in detail:
Market Volatility:
IPO shares can be quite volatile after they are listed. Many investors sell their shares after realizing the listing gain. Share prices can also fall due to the overall sentiment of the stock market and supply-demand factors. This is especially true when the market is in a recession mode.
Overvaluation:
Sometimes IPO companies offer their shares at high valuations, which do not justify their actual financials and performance. If you invest in IPOs of these companies, you may face losses after listing.
Lack of Historical Data:
Historical performance data for IPO companies is not readily available to the public, as this is the first time they are being listed on the stock market. This makes it difficult to assess the financial stability and growth prospects of the company.
Allotment Risk:
Popular IPOs are highly sought after, where not every applicant gets allotted shares. This is especially the case for retail individual investors (RIIs), who do not even get the minimum shares.
Economic and Sector-Specific Risks:
If the IPO company is in a sector that is cyclical in nature (such as real estate or aviation), then its performance may be greatly affected by broader changes in the economy. If the sector conditions deteriorate, investment may also be at risk.
Uncertain Future Growth:
The future growth of a company after an IPO can be uncertain. If the company fails to meet its projected targets, it may disappoint investors. As a result, they might decide to sell their shares, potentially causing the share price to decline.
Promoters’ Stake Reduction:
After an IPO, the promoters’ stake reduces and sometimes this can be a negative signal for investors, especially if promoters sell their stake aggressively.
Grey Market Premium (GMP) Dependency:
Many investors invest in IPOs based on Grey Market Premium (GMP), but sometimes GMP does not guarantee that the share price will rise after listing.
Conclusion:
IPO investment can be a great opportunity for investors wanting to join a new, fast-growing, and promising business. It is a way to get into a company’s early growth phase, which can provide good returns in the long run and, in some cases, in the short run. However, IPO investment is not always safe, as factors such as market volatility, overvaluation, and allocation risks can affect the outcome.
Before investing in an IPO, first thoroughly analyze the company’s financial condition, understand market trends, and keep your risk appetite in mind. Investing solely based on GMP in the hope of listing gains is not always profitable, so it is important to think from a long-term perspective.
Ultimately, it can be said that IPO investment can be a good option if you make informed decisions and align them with your financial goals and investment strategy. Research and patience are the two most important pillars for success in IPO investing.
