Risk of investing in an IPO | Motilal Oswal

Risk of investing in an IPO

The IPO market in India has been seeing increasing levels of activity in recent months. On a global scale, India holds the 4th position in terms of the largest number of IPOs. And the upcoming IPOs in 2022 also hold great promise for interested investors. But if you are planning to invest in an IPO this year, you need to be aware of the risks involved in the process. 

 

Merely knowing the benefits of an IPO is not enough. To have a solid investment plan in place, it is important to consider the downsides too. So, to help you get more clarity on the full picture before you invest in an upcoming IPO, here are the top risks that you should know about.

 

Key risks of investing in IPOs

 

1.You may not be allotted shares

One of the biggest risks you face when you bid for an IPO during the issue dates is that you may or may not be allotted shares, in the first place. Oftentimes, if an IPO is oversubscribed, many investors may not be allotted any shares. Alternatively, you may be allotted fewer shares than what you applied for. For instance, you may have applied for 50 shares, but you may end up being allotted just 10 shares. 

 

If the upcoming IPO in 2022 that you are planning to bid for is very popular, the chances of the company’s issue being oversubscribed are fairly high. So, this drastically reduces the probability of you getting the exact number of shares you apply for. Before you invest in an IPO, keep this in mind and have a backup plan in case you do not get any shares allotted to you, or if you only get a small number of shares in the allotment process. 

 

Because of this uncertainty, it is advisable to not make any solid plans for the profits you expect from your IPO investments. For example, if you have applied for an IPO, try not to jump the bandwagon and plan for a vacation or a big purchase with the gains you expect to make. This is because there is no guarantee on whether or not you will get shares allotted in the issue.

 

2. The shares may be overvalued

Considering the high volume of IPOs flooding the Indian financial markets in recent times, it is only fair to expect that most of these issues will not be fairly valued. Now, if an IPO is undervalued, it bodes well for the investors, because market correction will eventually bring the price up to its right levels. But given the high demand for IPOs and the high liquidity in the market, many IPOs are often priced well above the intrinsic value.

 

This means that over time, when the stock price corrects, it will reduce and get closer to its true value, leading to losses for IPO investors who hold the stock over the long term. So, the risk of overvaluation is another aspect you need to keep an eye out for if you want to invest in an upcoming IPO. 

 

Expensive valuation is a red flag that you need to look for before deciding if a company is worth investing in. Fundamental analysis can help you with this, since you can get a better idea of what the shares of the company are truly worth.

 

3. The listing day can be highly volatile 

Volatility is another big risk that is always present when you invest in the equity market. But it is even more relevant when you are going to invest in an upcoming IPO in 2022. When a stock is in the initial phase of its trading, the prices can be highly volatile. This is because in addition to the typical factors that affect stock prices, newly listed shares also show price fluctuations based on the changing investor sentiment in the market. 

 

On the listing day, this is even more noticeable. Many stocks show a great deal of price variations on the listing day. The price can skyrocket or it can fall significantly. In case the latter scenario occurs, you may end up facing huge listing losses. This is another risk that you should be prepared for. 

 

If you expect the price to plummet on the listing day, perhaps because of overvaluation or because of negative market sentiment, it is better to wait till the stock price has stabilised to invest in the company.

 

4. You may not have sufficient information about the company

If the company that is going for the IPO is fairly new, and if it has been in operation for just a few years, you may have trouble researching its true value. This is because there may not be adequate information about the company and its financial performance. You may also not have sufficient historical data to go with when you are evaluating the company’s shares. 

 

Although you can find some key details in the Draft Red Herring Prospectus (DRHP), some key details like the management’s efficiency, their revenue patterns, and the true potential of their business. These metrics are very vital if you want to figure out whether an IPO is worth investing in. Keep in mind that the absence of adequate information, however, should not be a reason to make an impulsive decision about investing in an upcoming IPO. 

 

Conclusion

Keep these risks in mind before you invest in any upcoming IPO in 2022 or later. And once you have a plan to invest in IPOs after accounting for these risks, you need to open a demat account to purchase equity shares. You can easily open your demat account with Motilal Oswal if you don’t have one already. The process of account opening is quick and simple, and absolutely free of cost. 

Related articles: 5 Tips for Investing In IPOs | What's the big deal about IPOs | Clearing the confusion from IPOs | IPO in India- The future looks bright | Upcoming IPO

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