It is true that some of the terminology associated with the securities market is not a part of the daily discourse amongst those who are not active participants in the market. There is one stock market term, however, that does seem to be widely understood, discussed, and quoted. This term is Initial Public Offerings or IPOs. In this article, we shall discuss the seven things to avoid before investing in an IPO.
What is an IPO?
For those who have never heard of an IPO, the first question the term engenders is what is the full form of IPO. Whenever a company issues its shares to the public for the first time, said issue is termed as an Initial Public Offering or an IPO, and the entire process is known as going public.
There are primarily two types of IPOs, namely a Fixed Price Issue and a Book Building Issue. While the former type of IPO comprises issues with a fixed offer price for shares, the latter IPO type is for issues with a price band instead of a fixed offer price.
Seven things to avoid before investing in an IPO
IPO investments are often marked by a sense of excitement and hope, specially if the company is a behemoth in its sector or an enterprise with immense potential for growth.
While each IPO investment must be gauged at its own merit, here are seven common mistakes investors can avoid while choosing IPOs to invest in.
- Not studying the company’s past performance
One of the biggest mistakes you must refrain from with regards to a prospective IPO investment is lack of due diligence, particularly about the issuing company’s financials. It is important to peruse and assess the past financial performance of the company – information that can be found in the public domain. You must also research the future plans of the company as well as its market standing and competitive advantage (if any).
- Following the popular opinion
When it comes to IPO investments, it can be tempting to follow a herd mentality and choose the issues that your friends, family, or colleagues find worthy.
Akin to any type of investment, however, IPO investment is fraught with risk and uncertainty, and each issue can hold different value and potential for different investors based on their life state, financial plans, etc. You must, therefore, form your own (and informed) opinion about an IPO investment.
- Getting enticed by potential listing gains
One of the major reasons why IPOs tend to get overhyped is the potential for listing gains. There is no certainty of the shares of any issuing company getting listed at a premium from their issue price.
Even if said shares get listed at a significant premium, looking at IPO investments as avenues for short term gains is not a prudent approach to investing. In a similar vein, even if an IPO you’ve invested in does not get listing gains, it is advisable to stay invested for the medium to long term for potential stabilising of the price and eventual gains.
- Overestimating the grey market premium
Another mistake to avoid while assessing IPO investments is overestimating grey market premium. When IPOs are traded unofficially post the closure of the issue, they often attract a premium termed as grey market premium or GMP.
This premium is completely dependent on investor perception about the issue and has no bearing at all on the listing price.
- Setting too much store by subscription hype
Although all companies try to create a buzz around their Initial Public Offerings, some IPOs attract more attention than others.
In the event of an issue becoming oversubscribed in the first day or two, there is often a misplaced perception about the issue being a worthy investment choice. It is pivotal not to be swayed by the aforementioned subscription hype.
- Not checking the valuation of the issuing company
While the marketing bubble surrounding an IPO can be substantial, it is critical to look at the real picture. In addition to a company’s past profitability and operational efficiency, you must also assess its valuation. Not only are IPOs avenues for new investors to become the shareholders of a previously privately held company, they are also exit routes for existing investors (mostly promoters). Checking the company’s valuation is of critical significance to ensure the investment is worthy of the risk it entails.
- Not considering your investment goals
It is easy to consider a prospective IPO investment on its own merit, but not as easy to assess it as a valuable addition to your investment portfolio.
Since every investor has their distinct set of investment goals, risk appetite, and investment timeline, it is important to weigh an IPO against your investment goals. Only then can you decide whether to opt for a particular IPO investment.
To Sum it Up
Investments in IPOs carry several risks, and it is easy to get swayed by the hype surrounding an issue. By avoiding the mistakes mentioned above, you can be better placed to choose the ideal IPO investments for your portfolio.
