Private businesses launch IPOs to raise capital from public markets, transforming into public entities in the process. It's a common growth trajectory, but there's a growing concern in India, as recently expressed by the Securities and Exchange Board of India (SEBI) pertaining to how retail investors approach IPOs.
54% of retail IPO share allotments are sold within a week, suggesting that many investors are simply hunting for quick listing gains rather than making long-term investments.
Of greater concern is the surge of small and medium enterprise (SME) IPOs, which differ significantly from mainboard IPOs. These offerings tend to be less transparent and are more susceptible to manipulation.
Let’s take a closer look at how "resourceful promoters" are making the most of these opportunities, and why the hype around IPOs often leads retail investors astray.
The Case of Resourceful Automobiles: A Reflection of SME IPO Hype
Consider the recent IPO of Resourceful Automobiles—a company operating just two bike showrooms with a total of eight employees. Despite its modest profile, the IPO was oversubscribed by over 400 times, with applications worth ₹4,800 crore against a request for just ₹12 crore. This kind of enthusiasm around IPOs suggests crazy belief from the retail investors, who believe it’s the ideal time to get in on a company, but that belief could be farther from the truth.
Here are 4 reasons, why SME IPOs tend to be Over-rated or Hyped:
1. Valuations May Not Be In Your Favour
Private companies usually launch IPOs during bull markets, when demand is high and promoters can command lofty valuations. As a result, the shares are sold at a premium. This phenomenon allows promoters and early investors (read VCs/PEs) to profit handsomely, while retail investors often overpay. Many retail investors subscribe to IPOs with the hope of reaping listing-day profits, but when the bull market ends, corrections can lead to far lower returns over the long term. In reality, what is often termed "IPO investing" is simply short-term trading—and it's quite a risky game.
2. You May Simply Be the Greater Fool
IPOs have two main purposes:
To access capital for expansion, working capital, or debt repayment.
To provide liquidity for early investors (read VCs/PEs), and promoters.
While it’s fair for early investors to reap rewards for their risk, the real issue arises when the primary purpose of the IPO is to provide a lucrative exit for the investors (read VCs/PEs), usually in cases of startups. Here, IPO (retail) subscribers become the "greater fools" paying high prices in the hope of finding an even greater fool to sell to at a profit.
As per the Greater Fool Theory, investing in overpriced assets during a bubble is unsustainable. If promoters are selling large quantities, it’s a warning sign: they wouldn’t cash out if they expected the share price to rise significantly in the future.
3. Listing Gains Are Not a Certainty
Many investors subscribe to IPOs with hopes of listing-day gains, but these gains are not guaranteed. In fact, according to a KPMG report titled "IPOs in India", 20-35% of IPOs yield negative listing gains, even during strong bull markets. Betting on a quick profit can be more of a gamble than a sound investment strategy.
4. Listing Gains Are Mostly Insignificant to Your Portfolio
Let’s say you do manage to hit the jackpot with listing gains. Will it truly make a difference to your financial well-being? Often, the returns are too insignificant to make a noticeable dent in your overall portfolio. It might give you a fleeting sense of achievement or some bragging rights, but in the bigger picture, it does little to support long-term wealth creation.
IPOs Through the Lens of Legendary Parag Parikh
A Smarter Approach to IPOs for Retail Investors
The enthusiasm for IPOs, especially among retail investors, is often misplaced. Instead of viewing IPOs as a sure-fire way to generate wealth, it’s better to analyze the purpose of an IPO, if this is an opportunity for early investors to cash out at your expense, then AVOID.
When considering an IPO investment, ALWAYS focus on the fundamentals i.e. why is the company going public, and where is the money being directed?
Long-term, sustainable growth comes from understanding a company's value, its competitive advantages, and its growth trajectory, and not from speculative bets on the listing-day gains.
A Smarter Approach to IPOs for Promoters
My philosophy encourages promoters to do the homework, and then aim for an IPO in the next 2-3 years. Ideally, the promoters must target ₹30-50 Cr annual revenue with ₹5-12 Crof profit benchmarks, to achieve a better valuation and less equity dilution at the IPO.
Final Thoughts: A Cautious Eye on the IPO Market
IPOs can certainly be part of a growth strategy, but they should be approached with caution and clear-eyed analysis. Instead of rushing to be part of the IPO frenzy, evaluate whether the company’s long-term growth aligns with your investment goals.
Remember, true growth is steady, sustainable, and built on strong fundamentals, and not on quick, unpredictable listing gains.
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