Investing in an IPO - Good idea or a bad one?

Published on 18th November 2020
An initial public offering, or IPO, is the very first sale of stock issued by a company to the public. Prior to an IPO, the company is considered private with a relatively small number of shareholders made up primarily of early investors (such as the founders, their families and friends) and professional investors (such as venture capitalists or angel investors). An overflow of Initial Public Offerings (IPOs) hit the market when the market is in an upward direction (bull run) and investors clamour to subscribe to most of these IPOs, hoping to make a kill on listing. But IPO investors do not always make profit all the time as has been proven time and again. In fact, in many of the IPOs, investors have burnt their fingers and suffered huge losses. Yet the herd mentality of the investors drives them to subscribe to the IPOs.

Of course, there is no denying the fact that there have been many IPOs that have given investors huge returns in the past, but these are honourable exceptions rather than the rule. The fact remains that most of the IPOs provide negative returns when markets have gone into a downward phase (bear run).

Promoters and initial investors usually come out with IPOs during the bull run to cash in on the booming market and get a handsome price for their shares. Since the boom in the market conditions create huge demand for IPOs, these IPOs get oversubscribed many times over. Due to the huge demand for stocks in the market, the stock prices may become inflated during the bull run and some of the IPOs may provide good returns to the investors on listing. But once the market conditions turn bearish, the inflated prices of these stocks slump, leaving the investors in a lurch.

Some of the notable booms and busts were the dotcom boom of 1999 that bust in 2000, real estate and infra boom of 2007 that bust in 2008 and the recovery of 2010-11 that petered out in subsequent years. The market has witnessed a bull run since 2015 and we have had a large number of IPOs during 2015 and 2016. Since then, there have been notable IPOs every year. Therefore, investors should not simply chase the IPOs blindly, but must be choosy while subscribing to the IPOs. They need to do their homework and subscribe only to the IPOs of the companies that have a great business model, are fundamentally sound and in good financial health. Only then, can they expect to get good returns on their investments.

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